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HMRC internal manual

International Manual

Thin capitalisation: practical guidance: private equity: risk assessment - the basics

Background information

Given the typical structure of a private equity buyout, and the nature of the loans under consideration, the general guidance in INTM513020 is probably only of limited relevance. However, the points about potential sources of information do apply. Private equity buyouts are normally well-reported, particularly the larger ones and there will usually be background information and commentary on the buyout readily available online.

Basic Ratios

The buyout involves the purchase of the shares of the target business so the market value of the target business (“the enterprise value”) is known at the time of the buyout. What can be more difficult to ascertain from publicly available information is the balance of debt and equity in the deal. This is because the term “equity” is often used by external commentators to describe all of the private equity house’s investment in the business even though some or all of that investment may be structured as debt. If, however, risk assessment is being carried out after the relevant return has been filed, the position should be disclosed by the accounts.

It can be helpful to consider the level of debt in relation to the enterprise value of the deal since it is a measure which can be used to compare with other known deals occurring at around the same time.

A high debt to equity ratio can be an initial risk indicator of non-arm’s length debt, although what is ‘high’ will depend on the borrower’s circumstances, particularly the nature of its business and when the loans were made.

As with thin capitalisation generally, other ratios that may be relevant to give an initial impression of the position are a leverage ratio such as debt:/EBITDA and an interest cover ratio such as EBITDA:/interest. Some of these are discussed in the chapters at INTM517000 and INTM518000 

Small and medium-sized enterprises

It is unlikely that a private equity buyout will qualify as a small or medium-sized enterprise - see INTM412070. Even if the business qualified as such before it was acquired, it is unlikely to qualify once linked enterprises connected to the private equity fund are taken into account.