Why don't financial sponsors use only senior debt for financing in LBOs?

In leveraged buyouts (LBOs), financial sponsors often utilize a mix of debt instruments, including senior debt and subordinated debt, primarily because of the strict lending limits associated with senior debt. Senior debt is typically secured and has priority over other forms of debt in the event of default, which means lenders will impose rigorous financial covenants and limits on the amount that can be borrowed. These constraints are put in place due to the lower risk associated with senior debt; lenders need to ensure that the borrowing company is capable of meeting its repayment obligations.

In many cases, the total leverage that can be obtained through senior debt alone is insufficient to finance the acquisition fully. Therefore, to achieve the desired financing level while managing risk, financial sponsors will supplement senior debt with other forms of financing, such as subordinated debt or equity, which can provide the necessary capital needed for the buyout.

The other options do not adequately capture the rationale behind the use of diverse debt instruments in LBOs. For example, while it is true that senior debt has interest payments and is commonly sought after, these factors alone do not explain the need for additional financing sources in a leveraged buyout context. Similarly, the availability of senior debt is not exclusively linked to large firms,