What is a capital stack, and why does the order matter?
It is the ranking of who gets paid, in what order, when there is not enough to pay everyone. That is the whole concept. Every price in the structure is a function of position in that queue, and every negotiation about a term is really a negotiation about position.
At the bottom sits senior secured debt, first in line on interest, on amortization and on the proceeds of any enforcement. Above it sits whatever fills the gap between what the senior lender will advance and what the transaction needs: second lien, mezzanine, subordinated notes, preferred equity, or a unitranche facility that collapses the first two layers into one document. At the top sits common equity, which is paid last, in full, or not at all.
The pricing follows the position mechanically. A senior lender at 2.0 to 2.5 turns of EBITDA is protected by everything beneath the enterprise value line and charges accordingly. A junior lender at the fourth turn is exposed to the same downside as equity for most realistic outcomes while capped at a coupon on the upside, and prices for that asymmetry. Nothing about the borrower changes between those two tranches. Only the queue position does.
The reason this is worth setting out is that owners routinely treat the stack as one financing with one price. It is not. It is three or four separate credit decisions taken by parties with different tolerances, and the cheapest layer is usually the one that has been negotiated hardest while the most expensive layer arrives late in the process, when the transaction has momentum and nobody wants to reopen it.
What does each layer cost right now?
At a one-month Term SOFR of 3.65% (CME, 4 August 2026), for a borrower below $10m of EBITDA: senior commercial bank cash flow debt runs S+350 to 425, or 7.15% to 7.90% all-in. Senior non-bank and unitranche runs S+550 to 750, or 9.15% to 11.15%. Junior capital and mezzanine, counting cash and payment-in-kind interest together, runs 13.00% to 16.00% (SPP Capital Partners, Market At A Glance, July 2026).
Further up the core middle market the layers separate more finely. Second lien prices at S+725 to 825 for borrowers with $15m to $40m of EBITDA, subordinated debt at an all-in 11.0% to 13.5%, and preferred equity at 13.5% to 16.5% for borrowers with $40m to $100m of EBITDA (Lincoln International, Private Credit Snapshot, as of 1 May 2026). Those are not alternatives to each other so much as consecutive steps up the same ladder.
Two costs sit outside every coupon in that list. Original issue discount on new-issue first lien and unitranche below $20m of EBITDA prices at 98.0 to 99.0 (Houlihan Lokey, as of 30 April 2026), with lower-middle-market unitranche quoted at 2% to 3% at funding (ABF Journal, 1 June 2026). On a five-year facility, two points of discount is roughly 40 basis points of yield that never appears as interest. Call protection commonly runs 102 in year one, 101 in year two and par thereafter, which a borrower expecting to refinance early is paying for and then exercising against itself.
The direction of travel on discount is worth noting because it is where the market has actually repriced. The share of lenders quoting original issue discount at 99 or tighter fell from 75% in the second quarter of 2025 to 56% in the second quarter of 2026, while quotes at 98.5 more than doubled from 18% to 42% (Houlihan Lokey, Q2 2026 Private Credit Survey). Spreads held. The discount moved.
| Layer | Turns it typically occupies | All-in cost | Loss position |
|---|---|---|---|
| Senior, commercial bank cash flow | 2.00x to 2.50x | 7.15% to 7.90% | Paid first, secured on the assets |
| Senior non-bank or unitranche | Up to 4.00x to 5.50x | 9.15% to 11.15% | Paid first, one document, more leverage |
| Junior capital and mezzanine | The gap to 2.50x to 3.25x total | 13.00% to 16.00% | Behind senior, ahead of equity |
| Common equity | Minimum 40% of capitalization | Not published | Paid last, in full or not at all |
“Owners negotiate the senior tranche because it is the biggest number and the first conversation. The layer above it is smaller, twice the price, and arrives when the process has momentum. That is precisely why it is where the money is.”
Where does the gap between senior and total actually sit?
It is narrower at the small end than most owners expect, and that is the constraint that shapes everything else. Below $10m of EBITDA, senior debt clears at 2.00x to 2.50x and total debt at 2.50x to 3.25x (SPP Capital Partners, July 2026). The junior layer is therefore about half a turn to three quarters of a turn wide. Above $25m of EBITDA, senior clears at 4.25x to 5.25x and total at 5.00x to 6.50x, so the junior layer is roughly a turn and a quarter.
Small businesses do not get a small version of a large capital structure. They get a shorter one. There is often no room for a genuine mezzanine tranche at all, which is why the practical choice below $10m of EBITDA is usually between a bank facility at two and a half turns and a unitranche facility at four or more, rather than between one stack and another.
That band has also contracted sharply. A year earlier the same sub-$10m cohort cleared 2.00x to 3.00x senior and 2.50x to 4.00x total: the senior band has lost half a turn and total leverage three quarters of a turn in twelve months (SPP, July 2026). Every turn removed from the debt has to be replaced by equity or removed from the transaction.
Equity is where the residual lands, and lenders now state their requirement explicitly: a minimum 40% base equity capitalization, with at least 60% of that in new cash rather than rollover. The loan-to-value evidence agrees. Unitranche loan-to-value sits at 50% below $100m of EBITDA and 55% above it (Houlihan Lokey, as of 30 April 2026), while a first-lien lower-middle-market book reports 29% weighted-average loan-to-value on new platform transactions at 2.8x weighted-average senior leverage (Capital Southwest, quarter ended 30 June 2026).
What does the whole structure cost together?
Work it once, on a stated structure, and the shape becomes obvious. Take a business with $10m of EBITDA financing at 3.0x total: 2.25x of bank senior at 7.15% to 7.90% and 0.75x of junior capital at 13.00% to 16.00%. Weighted by tranche size, the blended cost of debt lands at roughly 8.6% to 9.9%. The junior quarter of the structure contributes about a quarter of the debt and roughly a third of the interest bill.
Push the same business to 3.25x by adding a further quarter turn of junior capital and the blend moves to roughly 8.8% to 10.2%. That last quarter turn, which is the one most likely to be conceded late in a process to close a funding gap, costs 13% to 16% on its own and drags the whole structure with it.
That arithmetic is ours, not a published series. It uses the SPP ranges above at a stated tranche split, ignores original issue discount, arrangement fees and the difference in closing costs between one lender and two, and assumes both layers are available, which for many founder-owned businesses is the assumption that fails first.
What the arithmetic cannot tell you is the cost of the layer above it. No named source publishes required equity returns for lower-middle-market transactions as a current market series, so any blended weighted average cost of capital that includes an equity number is carrying an assumption rather than a citation. We do not offer one. What is observable is the position: at a 40% minimum equity capitalization, the equity is underwriting the first 40% of any value decline before the senior lender is touched at all.
Which layer is actually worth negotiating?
The one above the senior tranche, on almost any set of facts. It is the smallest layer, the most expensive layer, and the layer with the widest dispersion between what different providers will accept. A hundred basis points won on senior debt at 2.25 turns is worth less than a hundred basis points won on junior capital at three quarters of a turn only if the tranches are similarly priced, and they are not: one is at roughly 7.5% and the other at roughly 14.5%.
Within the junior layer, the terms that matter more than the coupon are the cash and payment-in-kind split, which determines how much of the cost hits liquidity now rather than principal later, and the equity component. Warrants, penny options or a conversion right are all forms of payment that do not appear in the stated yield and that only become expensive if the business succeeds, which is the outcome the owner is working toward.
Below that, three items are worth attention in every structure. Original issue discount, because it is quoted as a price rather than a rate and converts to yield the borrower will pay. Call protection, because it prices the option to refinance and a borrower who expects to refinance is buying an option against itself. And the intercreditor arrangement, because it determines who can do what to whom in a year when nobody currently expects anything to go wrong.
The last one deserves more weight than it gets at signing. A structure with two lenders and a well-drafted intercreditor agreement is easier to amend in year three than a structure with two lenders and a poor one, and the difference costs nothing at close. It is the clearest example of the general rule in this article: the cheapest thing to negotiate is always the term that does not have a price attached to it yet.
As of August 2026
Sources: SPP Capital Partners, Market At A Glance, July 2026, for the senior, unitranche and junior capital pricing grid, the senior and total leverage bands by EBITDA size band, the year-over-year comparison and the equity capitalization requirement; Lincoln International, Private Credit Snapshot, as of 1 May 2026, for unitranche leverage bands, second lien, subordinated debt and preferred equity pricing; Houlihan Lokey, as of 30 April 2026, for original issue discount by band and unitranche loan-to-value, and Q2 2026 Private Credit Survey for the year-over-year shift in discount quotes; ABF Journal, 1 June 2026, for lower-middle-market discount at funding and call protection convention; Capital Southwest, quarter ended 30 June 2026, for weighted-average senior leverage and loan-to-value on new platform transactions; CME, 4 August 2026, for one-month Term SOFR. The blended cost of debt figures are our own arithmetic on the cited SPP ranges at a stated 2.25x senior plus 0.75x junior structure, not a published series. The worked structure is illustrative and does not describe any transaction. No named source publishes required equity returns for lower-middle-market transactions as at August 2026.