Capital stack basics: who gets paid first and why it matters

Most real estate deals and many business acquisitions are funded by layers of capital. Each layer has a different place in line, a different set of rights, and a different cost. Together those layers are called the capital stack. Understanding it is the first step to structuring a deal that partners will fund and that the sponsor can live with.

The layers, from bottom to top

Think of the stack as a line for repayment. The layer at the bottom is repaid first and carries the least risk. The layer at the top is repaid last and carries the most.

• Senior debt. A first mortgage or senior loan secured by the property or the business assets. It is repaid first from cash flow and from sale or refinance proceeds.
• Mezzanine debt. A loan secured by a pledge of the ownership interests rather than the property itself. It sits behind the senior loan.
• Preferred equity. An ownership position with priority distributions and priority repayment ahead of common equity. Its rights come from the operating agreement, not a mortgage.
• Common equity. The sponsor and its investors. It is repaid last and holds the remaining upside and the remaining risk.

Not every deal uses every layer. Many deals are simply a senior loan and common equity.

Why position drives cost

Capital that is repaid first asks for less. Capital that waits longer asks for more. That can mean a higher rate, a larger share of profits, or stronger control rights. This is why the blended cost of a deal changes as layers are added.

A thin common equity check can look efficient on paper. It can also leave the sponsor with expensive capital above it and little room if the business plan slips.

Rights matter as much as price

Sponsors often compare layers on price alone. The documents tell a fuller story.

Senior lenders

Senior lenders set covenants, reserves, and reporting requirements. They control what happens at default through the mortgage and the loan agreement.

Mezzanine lenders and preferred equity

These positions often carry approval rights over major decisions. Some can replace the sponsor or take over the ownership interests if specific triggers occur. An intercreditor or recognition agreement with the senior lender governs how those remedies work.

Common equity

Common investors usually rely on the operating agreement for voting rights, reporting, and the distribution waterfall. Their protection is the sponsor's alignment and the quality of the plan.

Read every layer's remedies before signing. A cheaper layer with aggressive control rights may cost more in a difficult year.

Building the stack around the deal

A sound stack starts with the property or the business, not with the capital that happens to be available. A few questions are worth answering early:

• How much senior debt does the cash flow actually support?
• How long is the business plan, and does each layer's term match it?
• Where should control sit if performance lags?
• Does the senior lender permit mezzanine debt or preferred equity at all?
• What does each layer need at exit to be repaid in full?

The answers usually narrow the options quickly. They also show where a gap exists and what kind of capital can fill it without creating conflict later.

Sources and uses keep it honest

Every stack should tie to a sources and uses table. Sources list each layer and its amount. Uses list the purchase price, closing costs, reserves, and capital improvements. The two columns must match.

Partners at every level will review this page first. It should be clear, complete, and consistent with the rest of the package.

You can lay out the layers of a proposed deal with our capital stack tool. If you would like a second view on how to structure a specific transaction, contact us for a confidential conversation.

Thomas Capital Holdings does not sell securities or solicit investors. Any equity investment is made by the issuer under its own documents and applicable law.