INTM580020 - Thin capitalisation: private equity: Private equity buyout funding structures

The majority of 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 who will provide some of the funding. 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 bank debt, specialist financing such as from a mezzanine lender, loans from the private equity investors and management taking over the business (“shareholder debt”) and equity. The equity stake may comprise ordinary shares and preference shares. Sometimes, the vendors of the target business will also provide debt funding (“vendor loans”).

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 following diagram illustrates a typical debt buyout structure. It shows a target business being acquired for £100m with a mixture of senior, mezzanine 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.