Leveraged Buyouts (LBOs) are a cornerstone of private equity, heavily relying on debt to finance the acquisition of a company. This debt is not a monolithic entity; rather, it's a carefully structured mix of different instruments, each with its own risk and return profile. Understanding these debt layers is crucial for comprehending how LBOs are financed and how value is created (or lost).

In an LBO, debt is typically arranged in a 'stack' or 'waterfall,' reflecting its seniority in repayment. The higher a debt instrument sits in the stack, the lower its risk and, consequently, its interest rate. Conversely, lower-ranking debt carries higher risk and demands a higher yield.

The specific mix and terms of senior, mezzanine, and subordinated debt are critical to an LBO's success. A well-structured debt stack can maximize leverage, thereby increasing potential returns for the private equity sponsor. However, an overly aggressive debt structure can increase the risk of financial distress and bankruptcy if the target company's performance falters. Lenders and sponsors carefully negotiate these terms, balancing the need for capital with the acceptable level of risk.