This example involves preferred equity that carries an equity kicker. Investors may purchase preferred shares from the sponsor instead of, or in addition to, purchasing debt. In terms of liquidation priority, the preferred shares are senior to common shares but subordinate to first-lien senior debt. An equity kicker is an equity (ownership) instrument that adds value to debt.

This benefit may be offered by the borrower or demanded by the lender to sweeten the loan deal. Lenders provide financing to a company to help them achieve specific performance targets and increase the value of the company above its current fair market value. In exchange, the lenders get equity ownership that can only be paid if a breakpoint is achieved or a liquidity event occurs. Without any of these events happening, the lenders will continue holding their equity position. An equity kicker is an equity incentive where the lender provides credit at a lower interest rate and, in exchange, gets an equity position in the borrower’s company. An equity kicker is structured as a conditional reward, where the lender gets equity ownership that will be paid at a future date when the business attains specific performance goals.

Companies use an equity kicker to entice lenders to purchase a bond or preferred share from the company at a reduced interest rate. The lender may get an equity kicker from as low as 10% to as high as 80%, depending on how risky the portfolio is. I am a Spanish-fluent corporate and commercial real estate attorney and broker licensed in New York and New Jersey. My pragmatic approach towards conflict resolution allows me to provide valuable advice to clients on avoiding issues of liability through effective risk management and strategic allocation of resources.

  1. An equity kicker allows lenders or investors to enjoy the benefits of both a fixed-income return, similar to traditional debt financing, and a potential equity stake in the project or company they are funding.
  2. Three investors, A, B, and C, want to help finance Company X’s expansion.
  3. While equity kickers come with their share of benefits and risks, their increasing prevalence in commercial real estate and other industries underscores their importance in modern finance.
  4. It may also depend on a future event, such as the sale of the property, where the lender will receive a percentage of the sale proceeds depending on the amount of its interest in the business.
  5. Assume that the debt is structured as a warrant, where the lenders are given the option to buy a certain amount of stocks at a particular price at a future date.

equity kickers could be for as little as 10% or as much as 80% ownership in the company’s equity depending on the overall risk that the lender perceives. Equity kickers are usually triggered by the sale of the business or some other monetization event. Mezzanine lenders are paid after venture capital companies and other more senior lenders.

Calculating Real Estate Equity Kicker

The kicker may or may not actually be usable at any time during the life of the bond. Often a certain breakpoint must be reached, such as a stock price above a certain level, before the kicker has any real value. In addition, mezzanine and subordinated lenders use kickers to compensate for the increased risk of lending to certain companies. Assume that the debt is structured as a warrant, where the lenders are given the option to buy a certain amount of stocks at a particular price at a future date. For example, the borrower can give a 10% warrant coverage on the amount provided by each lender to the company.

Equity Kickers for Mezzanine Loans

In return for loaning money to the company, the lender will receive a stake in the company and a certain percentage of future profits. The https://1investing.in/ can be structured so that the lender receives a percentage of the gross rental income generated by the property if it exceeds a certain agreed-upon amount. It may also depend on a future event, such as the sale of the property, where the lender will receive a percentage of the sale proceeds depending on the amount of its interest in the business. Yes, there are alternatives to equity kickers in financing arrangements.

Loans

While equity kickers come with their share of benefits and risks, their increasing prevalence in commercial real estate and other industries underscores their importance in modern finance. An equity kicker is a type of loan product that is offered by a lender in exchange for a piece of equity in the project. This type of loan is typically offered when a commercial real estate borrower seeks out a mezzanine loan, but does not want to pay an extremely high interest rate. The lender may agree to reduce the interest rate in exchange for a piece of equity in the project.

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Think of an equity kicker as an additional incentive that boosts the lender’s return on investment. However, an early-stage startup may not have these records and may need money to finance its early-stage business operations. So, many young startups offer a kicker of equity as an additional incentive for investors to purchase their debt securities. The goal of a kicker is to solidify a deal that may not otherwise be realized without offering additional benefits to the lender. A kicker is expected to increase the lender’s return on investment (ROI). Three investors – A, B, and C – then come on board to finance XYZ’s expansion.

For example, suppose a borrower borrowed 1 million euros to buy a luxury home. The borrower uses the loan to complete the purchase and renovate the home for lease. Immediately after the renovations, the value of the house doubles to 2 million euros, due to the growing demand for this type of property. If the borrower initially provided 10% equity to sweeten the deal, it means that the lender will get a 10% share of the value earned by the property once it is sold. Suppose that the debt is structured as a guarantee, where lenders are given the option to buy a certain amount of shares at a certain price at a future date.

For example, the borrower may give 10% guarantee coverage on the amount provided by each lender to the company. Like all financial instruments, equity kickers come with both advantages and drawbacks. Below is a comparison table that elucidates the benefits and risks of employing equity kickers. In real estate, an EK may give you a share of the property’s income or gross rental receipts. You must be careful using real estate with this type of EK, as it is illegal in some jurisdictions.

This arrangement directly aligns the lender’s interests with the project’s success. Assets America was responsible for arranging financing for two of my multi million dollar commercial projects. At the time of financing, it was extremely difficult to obtain bank financing for commercial real estate. Not only was Assets America successful, they were able to obtain an interest rate lower than going rates.

An equity kicker is structured as a conditional reward, in which the lender obtains ownership of the capital to be paid back at a future date when the company achieves specific performance targets. In some cases, lenders or investors may directly receive an ownership stake in the property or project, which can be in the form of equity shares, partnership interests, or membership units in an LLC. This form of equity kicker provides lenders with a direct share of the property’s appreciation and cash flow. Warrants are financial instruments that give the holder the right, but not the obligation, to purchase a specified number of shares of a company’s stock at a predetermined price. In the context of real estate financing, lenders may receive warrants as part of the deal, allowing them to acquire an equity stake in the property or project later. You receive the convertible preferred shares along with the bonds you buy.

Equity Warrants vs Equity Kickers

Examples of liquidity events include initial public offerings (IPOs) and mergers and acquisitions (M&A). Companies that offer an equity kicker embedded option are mostly unable to access credit from traditional lenders. Lenders typically lend to companies with adequate cash flows to service the loan, as well as enough of an asset base to act as security for the loan. The alternatives to an equity kicker in commercial real estate are payment-in-kind interest (PIK toggle) and intercreditor agreements. PIK toggle is a process in which a borrower can avoid paying part of their interest until they actually repay their loan, by increasing the principal of the loan itself.

If the borrower initially provided an equity kicker of 10% to sweeten the deal, it means that the lender will get a 10% share of the value gained by the property once it is sold. Most companies that issue equity kickers are startups and early-stage companies that are yet to accumulate enough assets. They offer a kicker as a way of attracting investors who would otherwise be uninterested in lending to the company. Investing in commercial real estate also offers a number of tax benefits.

The riskiness of this type of investment is in between senior debt and equity. Mezzanine finance is often used for buyouts and acquisitions to prioritize new owners over existing owners. Early-stage companies seek alternative methods to gain investors’ trust, enabling them to offer lenders equity in exchange for a loan. It is usually used in management buyouts (MBOs), leveraged buyouts (LBOs), and equity recapitalizations.