Deep Equity Plan

Deep Equity is a description of Convertible Preferred Shares, often used in restructuring the balance sheet of an MBO company.

In a management buy out, management most often have significantly less available cash to invest than the net asset value of the target company.

To enable management to acquire a control block of common stock, lenders (usually banks) can provide long term finance in the form of Convertible Preferred Shares.

Example:

A management team want to buy out the subsidiary they manage. They can raise 5% of the asking price and they want the majority control block of shares.

First step is to set up a new shell company NewCo with a large number of low par value shares.

For example, if management have $50,000 to invest, NewCo can be created with 10,000,000 shares at $0.05 each par value.

Negotiate with a friendly bank to borrow a revolving line of credit for working capital and request the balance of funds to acquire the Net Book Value less working capital in the form of redeemable preferred shares, with a coupon, redeemable and convertible into a control block of common shares if lender's covenants became into default.

Funds released by the bank plus management funds are sufficient to purchase the subsidiary. The acquistion at net book value cost becomes a balance in the Total Assets column in the NewCo balance sheet. Any surplus of purchase price over net book value of the subsidiary becomes Goodwill, which is also an asset. Goodwill is depreciated in the profit and loss account usually over 25 or 40 years.

NewCo starts life with 10,000,000 "management" shares (in our example) and possibly 15,000,000 convertible preferred shares which can eventually be paid out back to the lender.

Reference Pages

Convertible Debt

Goodwill

Bank Covenants

Shell Company

Business Plan