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BRIDGE EQUITY
By: W. Michael Bond and David Herman
What is Bridge Equity? Bridge Equity is a financing
technique that allows potential acquirers of companies or
assets to commit to an acquisition before the equity necessary
for such acquisition is raised. By obtaining a Bridge Equity
commitment from a capital source, the acquirer can proceed
with a quick commitment, even though the ultimate equity
investors may not be located for a substantial period of time.
In essence, the Bridge Equity commitment obligates the
capital source to provide the required equity to the acquirer
and then locate syndication investors who are willing to
acquire such equity. Thus, the capital source bears the risk
that the syndication cannot be completed.
Advantages to Acquirers:
A.

Less Equity. Bridge Equity allows acquirers

the ability to commit to a transaction by
providing far less of the acquirers equity than
would otherwise be the case. In fact, the
acquirer may only be required to provide a
fraction of the equity that would be required if
the transaction did not have bridge equity.

B.

Timing. Bridge Equity allows Sponsors the

ability to move very quickly to commit to
acquisitions.
Since the Bridge Equity
provider is often the lender for the transaction
as well, the time required for underwriting,
due diligence and funding is not significantly
increased.

C.

Unlike traditional Bridge Loans which often

filled a gap in the capital stack prior to Bridge
Equity there is no collateral for Bridge Equity

and while there will likely be economic

consequences to acquirers if the Bridge Equity
cannot be timely syndicated (such as loss of
promote and fees), there is no ability of a
Bridge Equity provider to foreclose and wipe
out the position of the acquirer.
Representative Bridge Equity Terms:
D.

Bridge Equity Compensation. A Bridge

Equity fee is charged based on a percentage of
the amount committed (plus a higher
percentage of any amount actually funded).
The fee is customarily capitalized into the cost
of the transaction.
The Bridge Equity
provider also typically receives a fixed
percentage accrual on any capital that is
funded until such capital is syndicated. This
return is often paid by the syndication investor
who is then treated as having joined the
venture from inception for IRR calculations.

E.

Syndication:
1.

The time allowed for syndication may

be up to one year after closing in large
transactions.

2.

There is great variation in the

respective roles of the acquirer and the
capital source in the syndication
process.
The larger and more
experienced acquirers may want
significant control over the process
before a failed syndication.
Less
substantial acquirers may look to the
capital source to locate investors and
run the process.

3.

F.

Offering Materials - The sale of Bridge

Equity will in many cases qualify as
the offering of a security and
therefore it must be offered under
applicable securities law requiring
the acquirer and the capital source to
comply with applicable securities law
and exposing the acquirer and the
capital source to securities laws
liabilities for, among other things,
failing to adequately disclose the risks
of the investment. Thus, the parties,
will likely prepare a private placement
memorandum in order to make this
disclosure.
As a result, the
responsibility for preparation of the
private placement memorandum must
be allocated between the parties and
the parties must also allocate
responsibility and liability for claims
under the securities laws (whether
based on the contents of the private
placement memorandum or otherwise).

Failed Syndication Remedies:

1.

If there is a failed syndication after a

designated period of time, there are
usually consequences to the acquirer.
These may include:

Loss of promote
Loss of fees
Loss of control or decision making
rights
Loss of control or influence of
syndication process

Greater approval rights for capital

source and/or syndication investors
Subordination of acquirers equity
Increased returns to Bridge Equity
provider
Buy/Sell rights for Bridge Equity
provider
Forced Sale rights for Bridge
Equity provider

G.

Transfer Rights.
The acquirer would
typically be prohibited from transferring its
direct or indirect ownership interest until the
syndication is complete.

H.

Indemnification for Transfer Taxes. Many

Bridge Equity providers will insist on an
indemnity to protect it against any transfer tax
risk.

Structure of Bridge Equity Transactions. The goal of the

Bridge Equity provider is to structure the transaction in a
manner that provides the most efficient treatment to the
maximum number of potential investors. Thus, the structure
of the acquisition vehicle will be of utmost importance to the
Bridge Equity provider. The following is a brief overview of
some concerns that various classes of investors may have:
I.

U.S. Tax Exempt Investors.

1.

Non-Governmental
Plans
(Not
eligible for Fractions Rule). These
investors will typically be concerned
with unrelated business taxable income
(UBTI) and can generally avoid
UBTI by owning their interest through
a blocker corporation or a REIT. A
REIT is a much more tax efficient tax

blocker as there is no imposition of a

corporate level tax.
2.

Non-Governmental Plans (Fractions

Rule Eligible). To the extent the
transaction structure can be compliant
with the Fractions Rule (which is very
fact specific and beyond the scope of
this discussion) such investors can
avoid UBTI without the utilization of a
blocker corporation or REIT.

3.

Governmental
Plans.
These
investors will often take the position
that they are not subject to U.S. federal
income tax but if given a choice many
would prefer to invest through a REIT
to avoid any risk of incurring tax or
UBTI.

J.

U.S. Taxable Investors. These investors

should be indifferent to investing through a
REIT (except for the potentially draconian
consequences of failing to comply with the
REIT requirements and the potential taxes or
penalties that could be levied for noncompliance).

K.

Foreign Investors
1.

Foreign Governments. Most foreign

governments would want to invest
through a REIT (provided they own
less than 50%) thus allowing them to
avoid Federal income tax (pursuant to
Section 892 of the Code) on the sale of
shares in the REIT (if the exit strategy
is through a sale of REIT shares) as

well as on ordinary dividends received

from the REIT. As a result of a
recently enacted notice by the IRS
Section 892 cannot be used to exempt
foreign governments from Federal
income
tax
on
capital
gain
distributions
or
liquidating
distributions from a REIT if the exit
strategy is not through the sale of
REIT shares;
2.

Other Foreign Investors.

These
investors would typically be concerned
with effectively connected income
(ECI) and the potential requirement
to file U.S. tax returns. A foreign
investor in a REIT could recognize
income from its investment from three
sources: ordinary dividends, capital
gain dividends and gain on sales of
shares in the REIT.
Ordinary
dividends will generally not constitute
ECI but will be subject to withholding
at a 30% (or lower treaty) rate. Capital
gain dividends are subject to tax to
foreign investors under FIRPTA at a
withholding rate of 35% and are
treated as ECI, taxable to the investor
at U.S. graduated rates in the same
manner as U.S. investors are taxed on
that income. In addition, if the foreign
investor is a corporation it may also be
subject to the 30% branch profits tax.
The incurrence of ECI also causes
such investor to have a U.S. federal
income tax filing obligation. Thus,
foreign investors in a REIT will not

avoid the requirement of filing U.S.

federal income tax return if the REIT
disposes of any of its underlying
properties prior to the investors
disposing of their interest in the REIT.
Note that because REITs generally are
not in the business of holding
properties for short durations, a filing
requirement may not arise for the first
few years. Gain recognized by such an
investor upon a sale of shares of the
REIT will not be taxed under FIRPTA
if the REIT is a domesticallycontrolled REIT (more than 50% is
owned by U.S. investors).
L.

Investment Company Act of 1940. All

parties will typically seek to avoid the
obligation to register as an investment
company under the Investment Company Act
of 1940. Since limited partnership interests in
a limited partnership (generally the vehicle
that would be used in connection with
syndication) are treated as an investment
security the structure will need to qualify for
an exemption from the 1940 Act. Typically
limiting the pool of investors to qualified
purchasers or limiting the ownership to 100
or fewer beneficial owners would qualify for
such an exemption.

M.

Employee Retirement Income Security Act

of 1974. The goal of the structure will be to
allow ERISA investors to participate without
subjecting the transaction to ERISA fiduciary
rules or prohibited transaction rules. This can
be accomplished by having the investment
vehicle qualify as a VCOC or REOC.

Summary
Bridge Equity was developed as a natural
response to market conditions that required investors to move
quickly in order to be in a position to outbid rival potential
acquirers. It also provided capital sources with product to
distribute to syndication investors. While there are myriad
issues that must be solved in order to properly align the
incentives of acquirers and capital sources and to make the
investment attractive to a panoply of potential syndication
investors, the advantages of this product are apparent. How
this product will continue to evolve in light of over charging
market conditions will be important to all of the constituent
parties to these transactions.