What is an Equity Kicker?

An equity kicker is a lending arrangement in which the lender agrees to provide a reduced interest rate in exchange for an ownership position in the borrower. The concept can also apply to warrants that are attached to a bond issuance, giving investors the right to buy a certain number of the common stock of the issuer at a fixed price. These arrangements are designed to make it easier for a business to secure funds through borrowing arrangements. A subordinated lender that perceives a high level of risk with a proposed borrowing arrangement is more likely to demand an equity kicker, in order to make the return commensurate with the risk.

Equity kickers are especially common for startup companies that would otherwise have a difficult time attracting financing. They are also used for leveraged buyouts and management buyouts, where lenders need to be compensated for the increased risk associated with the underlying transaction.

Advantages of an Equity Kicker

There are several advantages to offering an equity kicker, which are as follows:

Advantages for the Borrower

Reduced interest rate. A borrower can use it to obtain a lower interest rate from a lender. This is quite advantageous when the interest rate would otherwise be unacceptably high, or when the borrower has little cash available for making debt payments.
Easier access to capital. Investors and lenders may be more willing to provide funding if they see a potential upside in the business.
Preserves cash flow. Instead of higher interest payments, a portion of the lender’s return comes from future equity, reducing immediate cash outflows.
Can attract strategic investors. If the lender has industry expertise, their equity stake can lead to valuable strategic partnerships and advice.
Improved equity ratios. If lenders obtain equity in the borrower, the borrower now has a more stable-looking balance sheet, since it has an increased amount of equity on its books. This can make the firm look more attractive to other investors and lenders.

Advantages for the Lender

Higher potential returns. An equity kicker offers an opportunity for additional gains beyond fixed interest payments, especially if the borrower grows significantly.
Downside protection. Lenders still receive fixed interest payments, and the equity kicker provides upside if the borrower performs well.
Encourages early loan repayment. Borrowers may want to repay the loan early to avoid dilution, leading to quicker returns for lenders.
Hedge against inflation. Unlike fixed interest payments, equity stakes can grow in value over time, providing a hedge against inflation and market risks.