In our holding company, where we start, acquire, and build businesses by deploying capital, time, talent, and technology, the temptation to squeeze every last basis point of efficiency out of the capital stack is always present. After all, a beautifully engineered blend of senior debt, mezzanine financing, preferred shares, and common equity can make a spreadsheet sing.
Yet we consistently step back from that edge. We believe that aiming for a perfectly tuned capital stack invites fragility, stifles flexibility, and ultimately undermines long-term value creation. Below is an inside look at the thinking that guides our more balanced approach.
The Allure of Over-Optimization
A sophisticated model can make over-optimization feel irresistible. Interest coverage ratios fall neatly into place, weighted average cost of capital (WACC) slides downward, and projected internal rates of return soar. Those clean outputs can lull even an experienced operator into believing that risk has been engineered out of the structure.
The problem: reality never behaves as tidily as a pro forma. Business cycles turn, covenants tighten, and capital markets seize up without warning. When that happens, any stack built to the edge of tolerance turns from a profit amplifier into a time bomb.
Spreadsheets Don’t Predict Storms
A spreadsheet is static; markets are not. Optimizing for the best possible cost of funds in the current moment can leave no slack for a sudden spike in rates, a geopolitical shock, or a supplier that misses deliveries.
We routinely remind our team that Monte Carlo simulations and scenario analyses are tools, not guarantees. By insisting on a margin of safety in each layer of the stack—even if that means a marginally higher WACC—we buy breathing room for the next curveball.
Why We Choose Balance Over Precision
Cost of Capital vs. Flexibility Preserved
Where each stack sits — the cheapest stack on paper is not always the one that survives.
A perfectly tuned WACC that cannot survive a bad quarter was never actually optimized — it was just fragile with better spreadsheet output.
Preserving Optionality
An over-optimized structure often relies on inflexible, low-cost debt that carries tight covenants and aggressive amortization schedules. While that setup lowers today’s interest expense, it also handcuffs tomorrow’s strategic moves. We would rather pay a modest premium for capital that allows us to:
- pursue bolt-on acquisitions when they become attractively priced
- ramp marketing spend in response to emerging demand signals
- ride out short-term margin compression without triggering default provisions
Optionality is an intangible asset that seldom shows up in financial statements, but it is invaluable during periods of volatility.
Managing Downside Risk
Conservative leverage levels protect equity during downturns and preserve relationships with lenders. In our experience, lenders remember borrowers who survive stress tests with minimal drama; those borrowers get the first phone call when fresh opportunities arise. By refusing to over-optimize the stack, we create a reputational moat that lowers future friction costs even if our current coupons are a touch higher.
Practical Principles We Follow
Theories matter, but investors and operators often ask how we translate philosophy into day-to-day decision-making. Below are guidelines that keep our capital stack balanced without drifting toward complacency:
- Maintain a minimum 25% equity cushion in every platform investment, regardless of lender enthusiasm.
- Structure covenants around cash-flow volatility bands observed in the prior ten-year cycle, not the most recent bull run.
- Use mezzanine capital sparingly and only when repayment can be fully supported by free cash flow under a “down-25% revenue” scenario.
- Keep at least one unencumbered subsidiary in the group to serve as collateral for emergency liquidity if credit windows slam shut.
- Refinance proactively when credit spreads tighten, but never extend maturities beyond the realistic life cycle of the underlying asset.
When we walk potential partners through these guardrails, most appreciate that they are designed to safeguard—not suppress—shareholder returns.
The Guardrails We Hold Constant
Practical principles, shown as current discipline against the minimum bar we set for ourselves.
These are not soft aspirations — they are the specific rules that kept the 60/40 deal liquid when the 80/20 deal was stuck in waiver talks.
Lessons Learned From the Trenches
Early in our history we did push the limits. A portfolio company in the specialty-manufacturing space was financed with an 80/20 debt-to-equity ratio because the lender was willing to stretch. When input prices spiked and customers delayed orders, EBITDA fell 30%. That shortfall violated a leverage covenant by a whisker, yet it triggered a cascade of lender rights: weekly reporting, spending caps, and the suspension of dividends to the parent.
Instead of focusing on operational fixes, management was tied up in waiver negotiations for months. We eventually stabilized the business, but the opportunity cost—in attention, momentum, and reputation—was painful.
Contrast that with another acquisition we entered at a 60/40 ratio despite pressure to go higher on leverage. COVID-19 cut revenue in half for two quarters, yet the business sailed through covenants. We were free to refinance at better terms in 2021 and even scooped up a distressed competitor with cash on hand. The equity used up front earned exponential returns because we stayed liquid when others could not.
Two Capital Stacks, One Recession
Indexed equity value through a downturn and recovery — illustrative, based on the two case studies above.
The 60/40 line does not just recover faster — it compounds past its starting point because it stayed liquid enough to buy while others could not.
The Opportunity Cost of Fragility
Over-optimization often masquerades as discipline, but it can quietly drain strategic energy. Leadership teams consumed by covenant calculations have little bandwidth for innovation. Staff hesitate to pitch growth projects if the slightest variance could breach lender thresholds. Vendors sense the tension and tighten their own terms.
Soon, a company that looked perfectly engineered on closing day operates like a marathoner who forgot to eat: all lean muscle, no reserves. By declining to chase the lowest possible cost of capital, we cultivate an operating environment where creativity and calculated risk-taking thrive.
Macro Tides and the Long Game
The last fifteen years have been a laboratory for capital-stack experiments. Ultracheap money rewarded optimization, while balance sheets with healthy padding were labeled conservative—or worse, inefficient. That narrative is changing as rates climb and liquidity fragments.
Our stance has not shifted, largely because it was never predicated on low rates in the first place. We design capital structures to survive unpredictable macro tides, knowing that true long-term compounding comes from staying in the game, not from maximizing any single bet.
Final Thoughts
Over-optimizing the capital stack can provide a fleeting boost to headline returns, but the hidden costs—fragility, lost optionality, strained relationships—compound over time. In our holding company, we choose resilience over razor-thin efficiency.
The flexibility bought by a slightly higher blended cost of capital pays for itself whenever markets wobble or once-in-a-decade opportunities arise. By anchoring our strategy in balance rather than perfection, we position every operating company, and the portfolio as a whole, to keep growing through whatever the economic cycle throws our way.
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