WTF is a Shareholder Loan (LBO Model)

Hey guys - can some please explain to me what a shareholder loan is in the context of a LBO. Specifically, I am wondering if it is: 

  • the most junior in cap structure (after mezz) but senior to equity
  • are interest rates PIK or cash only- are the interest expenses deductible for tax purposes, or are they treated similar to dividends (show up in cash flow, but you can't deduct them for taxes)
  • at exit, is this shareholder loan supposed to be fully paid off or does it show up in net debt number (inclusive of all other debt in the capital structure) 
  • any other thing unique about them that I should know?

Seems as if they are more common in Europe, as I am yet to come across them in the US. thanks in advance

 

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

 

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.

Global buyer of highly distressed industrial companies. Pays Finder Fees Criteria = $50 - $500M revenues. Highly distressed industrial. Limited Reps and Warranties. Can close in 1-2 weeks.
 

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.

 

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.

 

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