Basic, lesson 1 of 3
The capital stack from the sponsor's seat
Who lends into a buyout, where each lender sits, and what the sponsor is really shopping for when it raises debt.
9 min, 2 checks
1Four kinds of lender
A buyout's debt does not come from one place. A sponsor raising 400 of debt for a mid-sized company might deal with four different kinds of lender, each with its own reason to be there and its own idea of a good loan.
| Lender | What it buys | Why it is there | What it wants |
|---|---|---|---|
| Banks | Revolvers, term loan A, and the arranging role on term loan B | Fees for arranging and selling the loan, plus the sponsor relationship | To sell most of the term loan quickly and keep little on its own books |
| CLOs | Most of the syndicated term loan B market | Pools of loans financed with their own rated notes; they earn the gap | Floating rate, senior secured, rated, tradable loans |
| Direct lenders | Unitranche and other privately negotiated loans | Higher spread for holding the whole loan to maturity | Covenants, information, and a seat at the table if things go wrong |
| High yield investors | Fixed rate bonds, usually unsecured or second in line | Higher coupon for sitting lower in the stack | A liquid bond with a fixed coupon and call protection |
The bank is often an arranger, not a holder. It commits to the sponsor, then sells the loan on to CLOs and funds in syndication. If it cannot sell at the agreed terms, it may have to cut the price or hold the loan, which is why banks pull back fast when markets turn.
Check 1
Which lender is most likely to hold a loan to maturity and negotiate its terms directly with the sponsor?
2Seniority and security
Two separate ideas decide who gets paid first if the company fails. Seniority is the order of claims written into the documents. Security is a pledge of specific assets, usually substantially all of them, that a secured lender can take. A first lien loan is senior and secured on everything. A second lien loan is secured on the same assets but behind the first lien. An unsecured bond has no pledge and ranks alongside other unsecured claims such as trade creditors.
Further down sits structural subordination: debt issued by a holding company above the operating company is paid only from what is left after every creditor of the operating company, because the holdco owns shares, not assets.
3What the sponsor is shopping for
Students assume the sponsor wants the cheapest debt. It wants the best package across five things: cost, size, certainty that the money will be there at closing, flexibility to run the business (add-ons, dividends, more debt later), and the freedom to repay early without a penalty. A slightly more expensive loan that funds a bid the seller trusts can win an auction a cheaper, shakier package loses.
Worked example
Larkspur Foods: a two layer stack
- 1EBITDA is 80. The sponsor raises 5.5x, or 440 of debt.
- 2First lien term loan: 4.0x, or 320, at an illustrative 9.0%. Interest 320 x 9.0% = 28.8.
- 3Senior unsecured notes: 1.5x, or 120, at 11.5%. Interest 120 x 11.5% = 13.8.
- 4Total interest 28.8 + 13.8 = 42.6, a blended rate of 42.6 / 440, about 9.7%.
The notes are 27% of the debt but 32% of the interest. Junior debt raises leverage at a rising marginal cost.
Check 2
In the Larkspur stack, what is interest coverage (EBITDA over total interest)? Round to two decimals.
Terms in this lesson: Sponsor, Leveraged buyout, Revolving credit facility, Unitranche, Covenant, EBITDA.
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