Dieter Kerschbaumer, advisor at Arc & Co

Equity Masterclass: Structuring the capital stack, SPVs and shareholder agreements

In the second of this five part series of masterclass articles into equity funding, a deep dive is taken into how these deals can be structured.

Equity can be structured in various combinations, depending on the developer’s funding requirements, the scheme, investor approach, and whether a single-scheme or as part of a corporate growth strategy for multiple schemes.

As shown below, equity investment is predominantly raised behind debt in the capital stack. This means that investors are last to be repaid in the waterfall structure, which rationalises their requirement for a profit share in exchange for the risk associated with providing their capital.

Equity investment can achieve up to 90-100% of the total development costs, including 100% of build cost and monies towards purchase, with leverage being subject to an investor’s offering.

Figure 1: Equity in the Capital Stack  

An Intercreditor Deed (ICD) is required when multiple parties with charges are funding a scheme, including senior debt, mezzanine debt and preferred equity. This document sets out rights and priorities of returns of funders who have competing charges and claims on securities.

Equity investors can be selective when it comes to which lenders they’ll work with, therefore, strong relationships are fundamental when arrange this type of investment. Equity providers generally prefer to sit behind lower leverage debt, i.e., 50-65% loan to gross development value (LTGDV), as this reduces their risk through lower LTVs, protecting them against cost overruns, for example.

Equity investor returns on investment

The cost of raising equity investment usually involves one of the following means:

Pure Equity – this is a traditional method including a straight profit share between an investor and developer after all project costs, including a development manager fee for project operating expenses. Profit share percentages will depend on the investor and their minimum return requirements. Where there is no interest charged on the investor’s capital, there aren’t any securities or charges as with debt funding, and therefore no requirement for an Intercreditor Deed. Instead, a Shareholder Agreement is used to outline the rights of the agreement.

Preferred equity – the most common method of raising equity and similar to Pure Equity, however, investors charge an interest 'coupon' on their invested capital. An Intercreditor Deed is therefore required to outline the priority of repayment among the parties and securities.This method reduces an investor’s risk where they are paid interest on their invested monies prior to a profit share.

Each investor will have their own preference on the above methods, typically requiring a minimum return on investment of 20-25% per annum. If an investor is interested in supporting a scheme, they will inform the borrower of how they will need it to be structured. We will go into returns in more detail in a later article: Internal Rate of Return vs Equity Multiple.

Equity raising for single schemes: Intercompany Loan vs Shareholder Agreement 

There are two main ways equity can be provided in the borrowing structure for a single project:

1. Intercompany Loan – where an investor lends into the SPV, similar to a senior lender. They will have their own loan agreement in place, fully subordinated to the debt lenders’ capital via a Deed of Priority. Securities for this approach may include: personal guarantees (PGs), charges, repayment priority and collateral. This method is less administrative because there is no Shareholder Agreement, meaning that the decision-making rests with the developer, and investors have fewer rights and responsibilities compared to a shareholder.

Figure 2: Intercompany loan via preferred equity

2. Shareholder Agreement – where the equity investor becomes a shareholder of the borrowing SPV for a specific project. This provides ownership rights, roles, and responsibilities to an investor. Securities for a Shareholder Agreement may also include step-in rights, voting rights, information rights, or anti-dilution provisions and bad acts. 

Figure 3: Shareholder Agreement; preferred equity                                                                    Figure 3: Shareholder Agreement: pure equity              


Where another party is being brought into the borrowing entity, lenders will often require sufficient personal guarantee coverage from the developer for the debt funding provided.

A common misconception when raising equity funding on single schemes is that developers will have to exchange equity from their main limited company. However, where equity is provided at SPV level, the investors will only receive a share of the profits on the invested scheme.

Each investor will have their own preference on how the borrowing entity is structured. Legal counsel from a property solicitor should be sought when entering into funding agreements.

Shareholder Agreements: A solicitor’s advice, in partnership with BDB Pitmans

The shareholders’ agreement is a contract between the borrowing SPV and each investing shareholder setting out their respective rights and responsibilities.  With potentially large sums invested in a development project, it is important to focus on the detail of this contract.

Decision making 

The SPV operates through its board of directors and so it is important to agree from the outset which investors will be on the board and make the day-to-day decisions for the SPV.

Some development decisions carry more risk and financial consequence than others and shareholder agreements often restrict the board’s authority by a list of ‘Reserved Matters’ which require the board to obtain the prior approval of an agreed percentage of the shareholders before they can make certain decisions. This is a helpful mechanism to include for shareholders who are not on the board or are a minority, because it provides a degree of control in the decision making.

Shareholders who are appointed as directors of the SPV, should be conscious of their duties as a director which may not always completely align with their interests as a shareholder.

Development budget  

Preparing a property development budget which is forecasting 12 – 24 months in advance is always difficult, especially in the current economic and restricted supply chain market. Therefore, budget overspends are liable to happen.

The shareholders’ agreement should cater for this scenario and include covenants, for example (i) requiring shareholder consent before overspending reaches an agreed threshold (ii) restricting the SPV from calling down further equity from the shareholders if overspend reaches a pre-agreed level.

Such covenants can help to control the financial aspects of the development whilst acknowledging that the developer needs the flexibility to make decisions and progress the project.

Future funding 

The shareholders’ agreement should clearly set out the future funding requirements of each shareholder and importantly, the consequences of failure to fund the SPV when a drawdown request has been issued. 

For example, should the non-defaulting shareholders have the opportunity to fill the funding gap and invest proportionately more, or will external funding be the better option? 

The shareholders’ agreement should also set out what will happen to the defaulting shareholder’s investment and potential interest charges.

Information rights 

A shareholder of an SPV does not automatically have the right to see the management/annual accounts and day-to-day financial information of the SPV. 

To best protect their investment, the shareholders’ agreement should give each shareholder information rights detailing what information the SPV will share.  This also promotes trust and transparency between the developer and its investors.

Exit arrangements and step-in

 Understanding the exit strategy and proposed timescales up front is key to enable planning around timings for return of investment. The agreement should set out what is intended with the development once constructed (sale, lease, pre-lets etc) and the developer’s responsibilities in constructing and achieving a disposal.

The SPV should both own the land and have the benefit of any construction contracts etc, allowing a shareholder to continue to operate construction contracts and dispose of the scheme in the event of breaches by the developer.  In those circumstances you would expect the agreement to allow for deductions to the development management fee.  Following a successful disposal, the agreement will set out whether returns are paid on a phased basis, delayed until final disposal, agreed deductions and priority of repayment.

Courtesy of BDB Pitmans: Hollie Gallagher (corporate team) and Ellen James (real estate team).

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