The capital stack decision: how CFOs structure deal financing to control risk and return

The capital stack is the concept that trips up otherwise capable finance leaders when they move from operating roles into M&A. It sounds architectural because it is: you are literally deciding who gets paid first when things go wrong, and who captures the upside when things go right. Get the structure wrong and a sound acquisition thesis can collapse under its own financing weight.

Why the capital stack sits at the center of CFO responsibility

Most M&A commentary focuses on valuation, due diligence, and integration. The financing structure receives less attention in the press, but it is the mechanism that converts a deal's theoretical value into actual returns, or destroys them.

A CFO owns this decision in a way that no other executive does. The CEO cares about strategic fit. The board cares about earnings per share accretion. The CFO must hold both of those concerns in mind while simultaneously answering a harder question: if the acquired business underperforms by 20% in year two, does the financing structure allow the combined entity to survive that scenario without breaching covenants, losing access to revolving credit, or being forced into a fire sale?

That stress-test orientation separates capital stack thinking from simple cost-of-capital optimization.

How the capital stack works: mechanics and a concrete example

The capital stack is the ordered set of claims on a business's cash flows and assets. From bottom to top, it runs roughly like this:

• Senior secured debt sits at the base. Lenders here have first claim on collateral and accept the lowest interest rate because they carry the least risk.
• Senior unsecured debt ranks below secured lenders but above subordinated debt. No specific collateral, but still senior in a liquidation waterfall.
• Mezzanine or subordinated debt carries higher yields (typically 10 to 15% in a mid-market deal, sometimes including payment-in-kind features) to compensate for its junior position.
• Preferred equity sits above common equity but below all debt. It often carries a fixed dividend and liquidation preference.
• Common equity absorbs losses last and captures residual upside.

The practical decision a CFO makes is where to draw the line: how much of the acquisition price comes from each layer, and what does each layer cost in interest, covenants, dilution, or control?

Take a concrete case. Suppose a private equity-backed industrial company acquires a competitor for $500 million in enterprise value. A typical leveraged buyout structure in 2026 might look like this: $275 million in senior secured term loans (55% of the capital structure), $75 million in mezzanine notes at 12% with a five-year bullet maturity (15%), and $150 million in sponsor equity (30%). The debt service on $275 million at a floating rate of SOFR plus 350 basis points, with SOFR around 4.5%, means annual interest of roughly $21 million before the mezzanine coupon. Add the $9 million mezzanine coupon and you need the acquired business to generate at least $30 million in EBITDAEBITDAEBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) measures a company's operating profitability before financing and accounting decisions, used to compare core performance across firms.View full definition → just to cover financing costs before any principal amortization.

If the target was acquired at 10x EBITDA, that implies $50 million in current EBITDA, so coverage looks adequate at close. But the CFO must then ask: what is the EBITDA covenant in the senior credit agreement, what integration costs will hit EBITDA in year one, and does the business have working capitalworking capitalWorking capital is the difference between a company's current assets and current liabilities, measuring short-term liquidity and the funds available to run daily operations.View full definition → seasonality that could tighten liquidity during debt service periods? These are not theoretical questions. In the 2019 to 2022 wave of buyouts at compressed spreads, dozens of deals ran into covenant pressure precisely because the financing was sized to steady-state EBITDA without adequate headroom.

The role of hybrid instruments

The space between pure debt and pure equity has grown considerably. Convertible notes, preferred equity with PIK (payment-in-kind) toggles, and revenue-based financing have all become tools that CFOs use to bridge valuation gaps or preserve cash in the early post-acquisition period. In 2023 and 2024, rising base rates pushed many sponsors to favor PIK structures to defer cash interest, effectively deferring financing costs to a future refinancing or exit event. That can be a reasonable tradeoff, but it compounds the liability if the exit is delayed.

When to use each structure, and when not to

Heavy leverage makes sense when the acquired business generates predictable, contractual cash flows. A software company with 90% recurring revenue and low capital expenditurecapital expenditureCapital Expenditure (CapEx) is money spent to acquire, upgrade, or extend long-lived assets like equipment, property, or software that deliver value over multiple years.View full definition → requirements can carry more debt than a cyclical manufacturer. The 2021 acquisition of Qualtrics by Silver Lake and CPP Investments, at roughly $12.5 billion, leaned heavily into the recurring revenue profile to support a significant debt load. That logic holds until it does not: when growth slows or customer churncustomer churnChurn rate is the percentage of customers or revenue lost over a period. It measures how fast a business loses its existing customer base.View full definition → rises, the same fixed debt service that looked conservative becomes oppressive.

Equity-heavy structures preserve flexibility and reduce default risk, but they carry a real cost in diluted returns. If a CFO brings in a strategic co-investor to reduce debt, the combined entity's return on invested capital becomes hostage to that partner's exit timeline and governance preferences.

Mezzanine debt is often used as a gap-filler when senior lenders cap their commitment and the sponsor wants to avoid giving up additional equity. The honest tradeoff is that mezzanine lenders sometimes include equity kickers or warrants, which dilute the common equity even if no shares are formally issued at close.

The structure that creates the most value is rarely the one that maximizes leverage. It is the one that matches cash flow timing, risk tolerance, and strategic optionality to the specific deal. A CFO who anchors purely on minimizing weighted-average cost of capital will sometimes choose a structure that leaves no room for execution error.

The capital stack decision cannot be separated from the operating model of the acquired business. Before selecting instruments, a CFO needs a clear view of the target's cash conversion cycle, maintenance capital requirements, and downside EBITDA scenario. Get that picture right first, then build the financing around it.