Capital Stack
The capital stack is the hierarchy of financing in a deal or company, ordered by seniority and claim on cash flows.
Allocator relevance: Determines downside protection, recovery outcomes, and return profile across credit and equity structures.
Expanded Definition
Capital stacks commonly include senior secured debt, unitranche, subordinated debt, preferred equity, and common equity. Seniority defines who is paid first and what protections exist in stress. Yield, covenants, collateral, and control rights shape risk more than labels alone.
For allocators, understanding where a position sits in the stack is essential for assessing expected losses, volatility, and stress behavior.
How It Works in Practice
Underwriting evaluates borrower quality, leverage, covenant package, collateral, and downside scenarios. In stress, seniority and covenants determine negotiation leverage and recovery path.
Decision Authority and Governance
Control rights, covenant enforcement, and workout processes matter. Governance should ensure risk limits reflect stack exposure and that underwriting standards remain consistent across market cycles.
Common Misconceptions
- Seniority guarantees safety.
- Higher yield always implies better opportunities.
- Capital stack labels are consistent across markets.
Key Takeaways
- Position in the stack drives risk/return outcomes.
- Covenants and collateral shape protection.
- Scenario analysis should test recovery, not just base returns.