When you’re raising funds, structuring a deal, or considering outside investment, understanding the capital stack is essential. It defines the financial hierarchy in your business—who gets paid first, what risks each party takes, and how ownership and profits are shared.
What Is the Capital Stack?
The capital stack refers to the layers of capital that fund a company or investment, typically broken into four tiers:
- Senior Debt – The lowest risk and highest priority. Senior lenders are first to be repaid, often secured with collateral, and usually receive lower returns in exchange for this safety.
- Mezzanine Debt – A hybrid of debt and equity. It’s riskier than senior debt but offers higher returns. It’s often used when senior lending isn’t enough to cover the capital needs of a project or acquisition.
- Preferred Equity – Equity investors who are paid after debt holders but before common shareholders. They may receive dividends or special rights and have priority during distributions.
- Common Equity – The last to be repaid in a liquidation but with the most upside potential. Common shareholders own the business and benefit the most if it performs well.
Why the Capital Stack Matters
Understanding and structuring the capital stack strategically can:
- Attract the Right Investors
Each type of investor or lender has a different appetite for risk and return. Knowing where they fit in the stack helps you tailor your funding approach. - Minimize Cost of Capital
Debt is cheaper than equity—but too much of it increases financial risk. A balanced stack keeps your business stable while providing growth capital. - Protect Ownership and Control
By layering financing types wisely, you can raise needed capital while retaining a larger share of your company. - Clarify Investor Expectations
Every level in the capital stack comes with its own expectations around return, involvement, and exit. When structured properly, it creates alignment between founders and investors.
Key Considerations for Structuring Your Stack
- Leverage Carefully: Senior debt is cost-effective but too much can limit flexibility.
- Equity Dilution: Avoid over-relying on equity if maintaining ownership is a priority.
- Exit Strategy Alignment: Your capital stack should reflect how you plan to grow and exit. Investors at each level will have different time horizons and liquidity preferences.
- Legal and Tax Implications: Work with advisors to ensure your structure is legally sound and tax efficient.
Final Thoughts
A well-constructed capital stack isn’t just about funding—it’s about strategy. It influences how your company grows, how much control you retain, and how much value you ultimately create.
At CapCompass, we help business owners and founders navigate the nuances of capital structure, so they can raise funds without sacrificing their vision. Let’s build a smarter, stronger foundation together.