Primer
How to read a capital stack
Four questions that turn a list of loans and bonds into a view on who gets paid, in what order, and from what.
A capital structure table looks like a list. It is really a queue. Every lender to a company is standing in line for the same pile of value, and the table tells you where each one stands. Reading it well comes down to four questions.
1. Who is ahead of me?
Priority comes from two places, and you need both.
Liens decide who has a claim on specific assets. A first lien lender gets the proceeds of the collateral before a second lien lender sees anything. Unsecured lenders have no collateral and share whatever is left with everyone else who is unsecured.
Structure decides which company owes the money. Debt issued by the operating company, where the assets and cash flow sit, gets paid before debt issued by a holding company above it. A holdco note can be called “senior” and still be last in line, because its only asset is the equity of the business below.
Put the two together and rank every instrument from first paid to last. Instruments with the same rank share pro rata.
2. How much is ahead of me, in turns?
Dollars do not travel well between companies. Turns of EBITDA do. Divide the cumulative debt at each level by EBITDA and you get leverage through each class.
| Class | Amount | Cumulative | Leverage through |
|---|---|---|---|
| First lien term loan | $600mm | $600mm | 3.0x |
| Senior unsecured notes | $300mm | $900mm | 4.5x |
| Subordinated notes | $100mm | $1,000mm | 5.0x |
With $200mm of EBITDA, the unsecured notes occupy the slice from 3.0x to 4.5x. Those two numbers matter more than the coupon. The first is where your claim starts to be at risk. The second is the valuation at which you are paid in full.
3. What is the business worth?
Now compare the stack with value. If similar companies sell for 7x EBITDA, every class above is covered with two turns to spare, and the debate is about yield. If they sell for 4x, the value runs out in the middle of the unsecured notes. The first lien is safe, the unsecured notes get about two thirds, and the subordinated notes get nothing.
This is why the same company can have a loan trading at par and a bond trading at 40. They are claims on the same business, standing at different places in the queue.
4. What can change the order?
The table is a snapshot. The documents decide whether it stays that way. Three things to check before you trust it:
- Room to add debt ahead of you. Most credit agreements let the borrower raise more secured debt, sometimes a lot more. That debt goes in front of every unsecured lender.
- Assets that can leave. If the borrower can move valuable assets into subsidiaries that do not guarantee your debt, your claim on them goes with them.
- Maturities. A junior bond that matures before the senior loan can get paid at par while the loan is left with the risk. Time is its own kind of priority.
The short version
Rank the claims. Convert them to turns. Draw the line where value stops. Then read the documents to see who can move the line. Every credit page on this site is built around those four steps, and the stack chart at the top of each one is the picture of the first three.