Sweet Equity

Sweet equity refers to shares made available to management in a buyout on particularly favourable terms, usually at nominal value or close to it. The financial investor contributes most of its capital through a senior instrument, such as a shareholder loan or preferred shares carrying a fixed return, while management invests a comparatively small amount in junior ordinary shares. Only once the investor has recovered its capital plus the preferred return does the sweet equity share disproportionately in what remains, and that is where the leverage in the name comes from.

Economically it is therefore not a gift but an option: below the threshold management's stake is close to worthless, above it the value rises very quickly. The relationship between the entry prices is measured by the envy ratio. It is tied to vesting over the holding period and to leaver clauses that distinguish good from bad leavers and set the buy-back price at market value or at the lower acquisition cost accordingly. For German tax purposes the distinction between investment income and employment income is central. The case law of the Federal Fiscal Court turns principally on genuine downside risk and an entry price at market value.

Note: This explanation is for general information only and does not constitute tax advice. Tax treatment depends on the individual case and may change with new legislation. For a binding assessment, please consult a qualified tax adviser.