Why does a sponsor have two equity tranches (common equity + shareholder loan) in the S&U?
Sponsor equity is often split into two layers — common equity and a shareholder loan (also called 'PECs', preferred equity certificates, in a Luxembourg setup).
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| Aspect | Common equity | Shareholder loan / PEC |
|---|---|---|
| Form | Shares / units | Subordinated sponsor loan |
| Servicing | Dividends (rare in an LBO) | Interest (PIK or cash) |
| Tax treatment | Dividends not deductible | Interest deductible (capped by the interest deductibility limit) |
| Exit priority | Last (equity) | Ahead of common equity, behind Senior Debt |
Tax shield at the sponsor level — interest on the shareholder loan reduces the HoldCo's taxable profit. On $100m of sponsor equity split into $10m common + $90m shareholder loan at 8% PIK, ~$7.2m of annual interest expense arises at the HoldCo level — reducing taxable operating profit at the HoldCo/group level (exit gains on the shares are in any case largely tax-exempt under a participation exemption in many jurisdictions, often ~95%).
This is standard, but the interest deductibility limit caps the deduction at ~30% of EBITDA in many jurisdictions — seniors often ask when that becomes relevant. Answer: when the sponsor-loan volume is very large relative to EBITDA, or when operating-level interest already exhausts the limit.