INTM519020 - Thin capitalisation: practical guidance: private equity: private equity buyout funding structures
Many private equity backed acquisitions are achieved through a management buyout (MBO). In an MBO some or all of the existing management team of the target business purchase a significant share in the ownership of the business from existing shareholders. Often, management will do this with the assistance of a private equity backer. Private equity funds use a combination of their own funds, funds from the management team and debt to fund a separate company (a new company created for the purpose) that acquires the shares of the target company. The overall financing package will rely heavily on debt funding or “leverage”, hence the broader term “leveraged buyout” (LBO).
Such buyouts are typically funded through a mixture of
- third party debt, perhaps from unconnected banks, or specialist lenders
- shareholder debt, from the private equity fund, management team
- equity, for example, ordinary shares
The third party debt is usually the ‘senior debt’ because it will have the best security. Third party debt may also include a further slice of debt that is subordinated to the senior debt. This is referred to as junior debt (see INTM519030). This slice of debt is riskier than the senior debt. It will therefore have a higher interest rate.
Not all deals will include all of these components and the relative proportions of the various tranches of debt will depend on a number of factors including the circumstances of the business and the state of the debt market at the time the deal was agreed.
The following diagram illustrates a typical debt buyout structure. It shows a target business being acquired for £100m with a mixture of senior, junior and shareholder debt, and a small amount of equity.
The purpose of this diagram is to show a typical structure. Whether the funding is at arm’s length is a separate matter.
Use this link to view private equity buyout funding structures diagram
