Instruments In Private Equity Transactions (Video)

Private equity transactions involve a variety of financial instruments that enable investors and companies to structure deals according to their strategic and financial objectives. The primary instruments include equity and debt but also "in-between" instruments or any combination thereof. Understanding the characteristics and implications of each is essential for effective deal structuring in private equity transactions.

Equity - shares of all kinds, shapes and colours

The world of shares is remarkably diverse and provides large structuring flexibility, encompassing ordinary shares, preferred shares, ratchet shares, growth shares, hurdle shares, freezer shares, redeemable shares, deferred shares, capitalising shares, and distributing shares, to name just a few. Add to this the spectrum of "so-called" alphabet shares or combinations of dividend-paying and alphabet shares, and it becomes clear that structuring these instruments can be both creative and challenging.

Ordinary Shares

Ordinary shares represent the standard form of equity, offering no special rights beyond normal voting and pro rata economic entitlements. They may not be elaborate, but their simplicity ensures efficiency and clarity in ownership and control.

Preference Shares

Preference shares can have a variety of shapes, but their defining feature is generally their priority in ranking to ordinary shares and a predetermined annual dividend return, typically expressed as a percentage of the issue price. Preference shares may be structured so that accumulated dividends compound after a set period (usually one year). Unlike debt, these dividends do not accrue in the company's accounts until they are declared, and shareholders have no rights to them until that point. However, when calculating payouts, the virtual entitlement is considered. The economic terms of preference shares are essentially a formula, offering significant room for tailoring—whether adjusting the dividend base, the accumulation start date, or other features—to suit the needs of the transaction.

Ratchet Shares - Growth Shares - Hurdle Shares - Freezer Shares

While this type of shares may go by various names, their underlying purpose is consistent: they are designed to deliver returns above a specific threshold or internal rate of return (IRR). Typically, such shares serve as an additional incentive—often for management—to drive performance and maximize the sponsor's investment success. For instance, the terms might stipulate that any proceeds exceeding a set hurdle (which grows over time due to an applied interest rate) are distributed to these special shares, up to a certain cap.

Deferred Shares

Deferred shares represent the flip side of incentive shares: these are shares whose economic rights are reduced or switched off. For example, ordinary shares are converted into shares with minimal economic rights. Deferred shares are typically used as a sanction when holders have underperformed or failed to meet their contractual obligations.

For instance, if tax rules require that all shares are to be issued to management upfront, but participation should depend on meeting vesting or performance targets, some shares can lose economic rights if those conditions aren't met. Similarly, if call options can't be implemented, converting a portion of shares into deferred shares ensures underperforming holders do not fully benefit.

Deferred Shares can however also be used positively to boost returns on other shares. If management's return should increase upon achieving a performance milestone, but issuing extra shares isn't feasible, a portion of the sponsor's shares may be converted into deferred shares. This reduces the number of shares entitled to full economic rights, effectively increasing the return of each remaining share.

Debt

In addition to the more innovative and malleable options available within equity financing, it is important to remember that companies also rely on debt as a key component of their capital structure.

Debt financing encompasses a wide range of instruments, from traditional loans to more sophisticated options such as convertible or non-convertible bonds, notes, preferred equity certificates and profit tracking loans, to name just a few.

Unlike the flexible and sometimes intricate nature of equity arrangements, debt instruments are typically more conventional, offering predictability and clarity for both companies and investors. While debt may lack some of the excitement associated with equity, it plays a crucial role in funding business operations and managing financial strategies.

In-between

Turning to what might be called the "in-between" instruments—those that sit between traditional debt and equity. Only a few representative examples are summarised below. Although many other forms exist, the focus here is on key types for illustration. For the avoidance of doubt, this does not refer to hybrid instruments.

Beneficiary Certificates

Beneficiary certificates or profit units are not representative of corporate capital. The rights attached to these instruments are generally defined in the articles of association. As such, beneficiary certificates offer significant flexibility—they may include or exclude economic or voting rights, be convertible or not, and provide tailored governance rights, making them a versatile and valuable instrument worth considering when structuring transactions.

Warrants / options

Warrants and options are contractual instruments that allow holders to convert their investment into shares within a set timeframe. Legally, such instruments are initially considered debt securities—with no financial or voting rights—until they are exercised and converted into shares. Such instruments are not governed by company law, but rather by flexible contractual agreements, enabling parties to customise terms such as timing and conversion conditions.

CVRs: contingent value rights

Contingent value rights (CVRs) are contractual instruments that entitle holders to receive additional payments or benefits (including shares) if certain future events or financial targets are achieved. Commonly used in mergers and acquisitions, CVRs allow buyers and sellers to bridge valuation gaps by linking part of the transaction consideration to the occurrence of specific events, such as performance milestones. The terms and conditions of CVRs are set out in the relevant agreement, providing flexibility to tailor them to the needs of the transaction.

Private equity transactions draw on a broad array of financial instruments, each offering distinct advantages and structuring possibilities. Whether relying on traditional equity, classic debt, or innovative 'in-between' instruments, a clear understanding of their features and flexibility is essential. Careful selection and customisation of these instruments enable investors and companies to align deal structures with their strategic objectives and respond to evolving market needs.

Toinon Hoss and Frédéric Clasen conclude: "These instruments are not just legal tools, they are levers that shape the outcome of a Private Equity deal. Knowing how and when to use them makes all the difference."

This article was first published in Paperjam (October 2025). For further information, please visit [Paperjam].