Equity Trends – At a Glance
Management reinvestment amounts remained at the top end of traditional range, averaging 48% of proceeds (net of tax and costs).
The average sweet equity pot remained at 16% of the ordinary share capital, a figure which has remained steady over the past four years.
There was a continued high use of ratchets, which were used on approximately 55% of transactions.
Strip equity was subject to some form of leaver provisions on more than 80% of transactions.
Over 80% of deals had a fourth “very bad leaver” concept applying to certain securities.
The most common coupon on shareholder debt remained at 12%, higher than the traditional 10% rate.
Management Reinvestment
2024 saw the proportion of sale proceeds (net of tax and costs) that management reinvested remain in line with the historical highs seen since 2020, at 48%. Traditionally, reinvestment amounts have been between 25% and 50%, but since 2020 they have consistently remained at the upper end of that range, averaging between 41% and 48% and 2024 saw a continuation of that trend. This reflects sponsors seeking to bridge valuation gaps by requiring more sizeable management reinvestments.
Sweet Equity
The average sweet equity pot remained at 16% on mid-upper European focused deals. However, 2024 continued to see a range of pot sizes depending on: the (i) size of the deal; (ii) amount of shareholder debt, including the coupon applicable to it; and (iii) the dynamics of the management team. For example, transactions at the smaller end of the spectrum typically saw larger sweet equity pots as high as 20-25%, while the largest deals may have a sweet equity pot size below 10%. Generally, the examples which sit furthest from the average continued to result from large-cap transactions or transactions with non-European sponsors (in particular, US sponsors, where management incentive arrangements have historically tended to be less favourable to management).
The use of ratchets has continued to increase in 2024, with ratchets featuring on 55% of deals, continuing an increase in their prevalence in recent years.
Ratchets are typically being used as a tool to bridge expectation gaps between sponsors and management regarding the size of the sweet equity pot. In the higher inflationary and interest rate environment of recent years, sponsors have been more cautious in their growth projections for investments, especially where acquisition pricing has remained high. Ratchets have allowed sponsors to incentivise management teams to drive exceptional performance whilst not having to sacrifice returns where growth is in line with more conservative projections. We expect to see this trend continue throughout 2025 given current and projected economic conditions and the continued difficulty of aligning expectations between management teams and price conscious investors.
The amount of additional equity available in excess of the hurdle typically ranges from 3.5% to 20% on mid-upper European focused deals, with most ratchets involving a money or invested capital multiple test and, often, an additional IRR test. Ratchets continued to be almost exclusively “top slice” ratchets (where additional equity is calculated by reference to the proceeds above the relevant hurdle only) as opposed to ground up or “cliff” ratchets (where additional equity is calculated by reference to all proceeds).
Shareholder Debt
Preference shares continue to be the predominant form of shareholder debt in 2024, with almost all transactions using preference shares as the only fixed coupon instrument and only a small minority of deals using both preference shares and loan notes. This reflects the prevalence of US investors in funds who tend to favour preference shares over loan notes due to the poor tax treatment of loan notes in the US. There are also an increasing number of limitations on the tax deductibility of loan note interest as a result of the corporate interest restriction and anti-hybrids rules, making loan notes generally less attractive than they once were. Where transactions utilise a blend of preference shares and loan notes this is often for deal specific reasons with the aim of facilitating the extraction of cash without any requirement for distributable reserves, which can be a particular concern if the AIFMD asset stripping rules apply.
The most prevalent shareholder debt coupon remained at 12% in 2024, in line with the numbers seen in 2023. This reflects the continued high interest rates globally which has increased the pricing of bank debt and made a higher coupon on shareholder debt necessary for investors to deliver the required returns. Annual compounding of interest remains by far the most common, rather than semi-annual or quarterly compounding.
It had been expected that global interest rates would continue to fall in 2025 but the recent imposition of tariffs on various trading partners by the US and the threat of a looming ‘trade war’ could result in increased inflationary pressures and potentially slow the projected rate of interest rate cuts. It therefore remains to be seen whether there will be a material fall in global interest rates over the next 12 months which results in a reduction on the average shareholder debt coupon.
Follow-on Funding
2024 saw a minor drop to 22% in the number of transactions involving the use of non-dilutive funding (where the investor agrees that, should any further funding be provided post-closing, such funding would be structured so as to not dilute management’s equity).
Whilst non-dilutive funding is often a key way for sponsors to differentiate themselves in competitive processes, particularly for businesses with a strong M&A platform, the less competitive nature of processes in 2024 meant many sponsors did not feel compelled to offer this as part of their bids. Ongoing uncertainty over the cost of capital also meant sponsors did not want to hardwire future funding arrangements and instead preferred to agree appropriate terms at the time it is required.
Where non-dilutive funding provisions were included, the average amount of non-dilutive funding averages between 2 to 6% of enterprise value.
Leavers
Sweet Equity
The good leaver, intermediate leaver and bad leaver construct continues to be the most prevalent construct for valuing a leaver’s sweet equity, with most transactions now also involving a very bad leaver concept.
Over 80% of deals in 2024 saw the use of a vesting period of four years. Vesting linked to an exit (where management are only entitled to receive full value for their sweet equity if they remain with the business until exit) also remained the most commonly adopted approach. Value vesting (rather than ownership vesting) also remains the standard on European deals.
The most common method of pricing sweet equity shares held by leavers in 2024 continued to be: (i) fair market value for shares held by good leavers and for vested shares held by intermediate leavers; and (ii) the lower of issue price and fair market value for shares held by bad leavers and for non-vested shares held by intermediate leavers.
Strip Equity
The use of “very bad leaver” provisions which apply to strip equity in limited circumstances (such as summary dismissal or breach of restrictive covenants) continues to be the market standard in 2024 and again increased in prevalence. Very Bad Leaver provisions were seen on over 85% of transactions in 2024, compared to 80% of transactions in 2023 and 73% for 2022).
The consequences when leaver provisions are applied to strip equity can include some or all of: forfeiture of some or all of the ordinary equity component, reduction of future coupon accrual, or on some transactions, forfeiture of accrued coupon.
The circumstances in which leaver provisions are applied, and the consequences when they do, continue to be subject to specific negotiation on a deal-by-deal basis and on 30% of transactions in 2024, different leaver provisions applied to Tier 1 and Tier 2 management. In addition, we continued to see a trend for certain individuals to negotiate personal leaver terms by way of a separate agreement or side letter (most commonly (i) senior individuals that are close to retirement and the business need for their continued contribution has influenced their negotiation power; and (ii) CEOs agreeing favourable terms outside of more investor friendly terms referred to above).
Restrictive Covenants
The most common duration for the restrictive covenants given by Tier 1 management remained at 24 months in 2024, in line with 2023 but longer than the 18 months which was most common in 2022. The most common length for Tier 2 management remained the same, at 12 months.
Investment Agreement Warranties
The scope of investment agreement warranties has remained relatively unchanged in recent years, with key members of management typically being asked to warrant (on a several basis) certain factual information in the core due diligence reports and personal questionnaires. The purpose of these investment warranties is primarily to elicit disclosure and focus the minds of key members of management, rather than to achieve substantive financial recourse. Consequently, the caps on liability remain at 1 – 2x the manager’s salary, with most deals in 2024 adopting a 1x cap. The most common time period for these warranties was 12 months, which was adopted on over 80% of transactions. The second most common time period was 18 months, which was seen on a small minority of deals.
2024 also continued the trend of additional limitations (e.g. blanket awareness, de minimis and thresholds) which were historically more commonly used in respect of acquisition warranties, increasingly applying to investment agreement warranties.
Investors’ Fees
The percentage of deals involving arrangement fees, monitoring fees and director fees remained steady in 2024, as did their quantum. The use and quantum of such fees continues to be largely driven by the terms agreed between a sponsor and its limited partners, rather than market conditions.
