WTF is a Shareholder Loan (LBO Model)

Shareholder loan is a source of financing for an lbo. Basically you agree with the seller to pay them part of the exit price after an agreed upon time with a specified rate so that it decreases the amount of capital needed for the acquisition. Aside from decreasing the cash needed it can be used as a signal of confidence from the seller - in theory they would not agree to a sellers note if they are not comfortable with the company or are worried about its solvency. Where it is in the cap structure differs but is usually the most junior debt

A shareholder loan can be used as a means to maximise your tax-deductible interest. By providing a SHL to an entity, the interest payable on that loan provides a tax shield. See below for a discussion on SHLs on wso.

https://www.wallstreetoasis.com/forums/role-of-shareholder-loans

Shareholder loan on an existing balance sheets is almost certainly secured in some way but subordinate to any outside secured debt. So the shareholder lends money in and they are smart enough to collateralize it with a lien, but they will always be (allow themselves to be) pushed back as new debt comes in. But that security puts them above trade/vendor debt in payout or liquidation. These notes are often converted to equity (wiped out) in a challenged acquisition.

just had an add on question - why not do more of a shareholder loan instead of equity? ie get a tax deduction but funder is the sponsor in both cases. restrictions from other creditors on total leverage ratios without debt carve outs?

PIK interest is deductible from issuers’ perspective though the lenders (aka sponsors in this case) may need to report income on their tax returns as well, so they are stuck with PIK interests while have to come up with cash to pay taxes early. From a modeling standpoint, it really doesn’t matter if you look at it as debt or equity upon exit, as the proceeds will go to the sponsors either way. One caveat to tax deduction: if it triggers AHYDO rules, interest deductions for issuers will be limited.

Key words: arms-length, interest deductibility, tax structuring

It’s a European construct for tax structuring. My understanding is that is purely for tax structuring, by running some PIK that is tax deductible, subject to thin capitalization rules.

From an IB perspective and for modeling purposes you treat it as equity.

Hi, 

So should the 'interest' payments (e.g. PIK that accrues) go through the PnL? (i.e. deduced before EBT?) 

Thanks