LegalLingo: What is 'institutional strip' and 'sweet equity'?

Being an aspiring commercial lawyer often means being confronted by complex, often abstract, concepts leading to an often impenetrable wall of jargon for students and trainees. Next up in our LegalLingo series, which we've introduced to help break down this jargon, is a '101' on institutional strip and sweet equity.

'Institutional strip' and 'sweet equity' are two cornerstone terms used in private equity transactions.

Institutional strip refers to securities invested into by (institutional) private equity sponsors to fund the purchase of a target business.

Institutional strip will typically consist of a combination of ordinary shares and preference shares or loan notes. Alongside the private equity sponsors, senior / key members of a target’s management team will be expected to either rollover existing equity interests in the target or otherwise invest their own cash to subscribe for institutional strip. The intention is for the management team to put 'skin in the game' (i.e. bear the financial risk of the acquisition alongside the private equity sponsor), thereby creating alignment between the sponsor and the management team.

Alongside the concept of institutional strip, sweet equity operates to incentivise the management team with the growth / performance of the target business. In UK private equity transactions, sweet equity typically takes the form of ordinary shares held by the management team, which will appreciate in value as the target business grows. This serves to incentivise management to promote the success of the business and maximise its value.