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ACCA Strategic Professional · Advanced Financial Management · Business re-organisation

In an MBO, the management team is given a 'sweet equity' stake by the private equity investor. What is the main purpose of this arrangement?

Sweet equity gives managers a larger share of ordinary equity than their cash investment would justify, so they benefit disproportionately if value grows. This aligns management incentives with those of the investor and motivates performance, rather than affecting debt, due diligence or creditor ranking.

  1. ATo align management's incentives with equity value creation by giving them a disproportionately large share of the upside relative to their investmentCorrect
  2. BTo reduce the level of debt the buy-out vehicle needs to repay
  3. CTo avoid the need for any due diligence by the investor
  4. DTo ensure that senior lenders rank behind management in a liquidation

Explanation

Sweet equity gives managers a larger percentage of ordinary shares than their cash contribution justifies, so they gain strongly if value rises. This motivates performance and aligns interests. It does not reduce debt, replace due diligence or change creditor ranking.

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