A sponsor structures: $100m common equity (90% PE fund, 10% management rollover), $50m PIK shareholder loan at 10%. What are the implications?
$150m sponsor total, split into $100m common equity (90% PE fund, 10% management rollover) and a $50m PIK shareholder loan at 10%.
- PIK capitalizes: $50m × 10% = $5m per year added to the loan, no cash out. After 5 years the loan stands at ~$80.5m.
- Tax shield at HoldCo: the $5m interest expense is deductible (unless the interest deductibility limit bites), saving ~$1.5m per year.
- Management alignment — a $10m investment in common equity turns into $25m at a 2.5x exit multiple — strong motivation, but lock-up risk if management leaves before exit.
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- Common equity multiple at exit: the main share. $100m of common equity at 2.5x becomes $250m.
- PIK loan accretion: secondary, but tax-free for the sponsor. $50m at 10% PIK compounds to ~$80.5m over 5 years.
The standard is a 4-year vesting with a 1-year cliff. Good-leaver clauses (retirement, death, disability) grant full vesting plus a fair-market buyout. Bad-leaver clauses (termination for cause, non-compete breach) trigger forfeiture of the unvested portion and usually a cost-basis repayment on the vested portion.
Question: "What happens to management equity if someone has to leave before exit?"
Answer: "The vesting schedule and good-leaver / bad-leaver clauses in the SHA (shareholders' agreement) govern this. The standard is 4 years' vesting with a 1-year cliff. A good leaver receives full fair-market value for vested shares; a bad leaver forfeits unvested shares and gets only cost basis back on the vested ones"