Equity Kickers, likewise called kickers, boost investor’s confidence in any organization which seeks loan or investment from them. In return for their loan financing, investors or loan providers can own an equity share, warrants, or common stocks in the company at a future date. This is in addition to the interest as per the terms of the issuance of the security. The equity kicker helps the borrower get loans at a cheap interest rate and entice the lender to grant loans. Whereas the investors get more return or bigger share in profits by way of becoming equity shareholders. And thereby increasing their overall return on the loans granted. Budding organizations utilize an equity kicker for funding their operations.
Budding organizations and new entrants generally find it hard to draw investor’s interest. Being new in the industry, it is difficult for new firms to gain investor’s trust. Therefore they offer equity kickers to attract the investor. On the other hand, the mezzanine investors who anticipate a high-risk level with a proposed borrowing agreement presumably demand equity kickers to neutralize the risk.
Various Types of Equity Kickers
It is a certificate issued with security that gives the holder a choice to buy a stock for a definite period or on a specified time and date for a particular price.
Example – A Company ABC gives 2% equity for every 10 Million of loans granted by the investors. Three investors – R, T, and U – are willing to invest in ABC. Investor R is willing to provide 20 Million, while T and U are ready to contribute 10 Million each. Now, in terms of the Equity warrants, the investors will get equity warrants for 2% of the invested amount. Therefore, R will get equity warrants equivalent to 4% or for 0.4 Million while T and U will get warrants equivalent to 2%, ie. 0.2 Million each.
Convertible Preferred Stock
Preferred stock carries a fixed rate of dividend payment every year whenever there are profits. And they remain redeemable at a specified date as per the terms of the issuance. To add kicker, the company can issue Convertible preferred stock that provides an option for converting a portion of the stock to the common stocks or equity. Thus, the convertible tag is the kicker for the investor to subscribe to such stock. This gives a fixed rate of return and allows them to participate and acquire the company’s equity shares at a specified date and a specified price. And thus allows the investor to pocket the appreciation in the share prices.
Example – For example, Company ABC may issue a Convertible preferred stock, carrying a yearly dividend of 5%, with a right to convert 10% of the preferred stock into equity at par at the end of 5 years from the date of issue. Three investors – R, T, and U – are willing to invest in ABC. Investor R is willing to provide 20 Million, while T and U are ready to contribute 10 Million each.
So, R gets an equity kicker of 5% or conversion rights for a value of 1 Million at a pre-determined price. Similarly, T and U both will get equity conversion rights for a value of 0.5 Million each.
Uses of Equity Kicker
An equity kicker is desirable for early-staged firms as it is unlikely for them to get investment from traditional lenders. The reason being- they neither have adequate assets for collateral nor sufficient cash flow. To attract investors and lenders, they incentivize them by offering an equity kicker.
Mezzanine financing transactions also generally use Equity kickers. Here the investor receives equity interests in the borrowing company as an extra monetary reward for lending them.
It is a cross of obligation and value financing. Mezzanine financing gives the bank the option to become the equity shareholder of the company under specified circumstances. It happens when the company defaults in payment of interest and principal installments continuously as per the terms of the agreement to the bank. These warrants increment the estimation of the subordinated debt valuation and permit more adaptability when managing bondholders. In mezzanine financing, it occurs after the senior debtors are paid, and financing is done to the organization.
What is in it for Investors?
Despite lending at a low-interest rate as part of the deal, it’s a long-term profit/return source for the investors. They can avail of this equity ownership at a future date when the event occurs. How low or high equity kicker the lender will get depends upon how risky the portfolio is. It can be as meager as 5% or as huge as 50% depending upon the risk involved in the investment and what is mutually agreed between the parties at the time of the transaction or issuance of bonds.
Investors or lenders get a fixed rate of interest regularly and a share in the company’s equity. Therefore, the lenders and investors also get the usual dividend as and when declared being an equity shareholder too. Moreover, over the year, with consistent profit and market prospects, the equity shares of the company may be commanding a premium in the market. Hence, the investors or lenders also get that capital appreciation as part of this deal. Thereby there are 3 types of earnings possibility for an investor in such types of deals – fixed rate of interest on the bond or money lent. Second is the dividend on the equity shares and, finally, the capital appreciation on share prices.
What is in it for Borrowers?
Traditional lenders generally lend to well-established companies. These companies have a sufficiently high cash flow to repay the borrowed money on time. They also have reliable collateral for the loan. And all these comforts are not available with new companies or companies not doing well but seems to have a promising future. Equity Kickers help the new players in getting a fair chance to compete by getting investments and loans by diluting or sharing a part of the future capital appreciation.
Real Estate Industry and Equity Kicker
In real estate transactions, an Equity Kicker may give you a portion of the property’s sale value or gross rental receipts. One should be cautious utilizing land with this Equity Kicker deal, as it is unlawful in a few states and countries. In such an arrangement, a land value warrant gives investors a bit of value in the land venture. It is of use for a mezzanine credit when borrowers would prefer not to pay incredibly high interest on a loan, i.e., the lender may agree to lend at a lower rate to get value in the property.
Advantages & Disadvantages of Equity Kickers
These equity kickers could be of immense help in sustaining and surviving the new or upcoming organization. Thus, the loan installment gets a moratorium or reduces to the extent of the kicker part. This is in addition to the lower interest rates on the money borrowed. Thereby the stress on cash flow in the initial stages could be relieved a lot.
It also allows opportunities for new companies to gather resources for their venture.
However, on the opposite side, the investors will expect and do merit these kickers because of high uncertainty and risk. And obviously, the company also need to part with some of their long-term benefits to sustain during the initial phase. Hence, it could be a profitable compromise if the funding is of immense importance, multiplying the business prospects overall.
Quiz on Understanding Equity Kicker
This quiz will help you to take a quick test of what you have read here.
Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".