Why management and sponsor can pay the same price per ordinary share and still enter at prices twenty times apart, and what that does to each side's multiple at exit.
The envy ratio is the price the sponsor pays for 100 per cent of the equity divided by the price management pays for it: (sponsor investment ÷ sponsor's share of the ordinary) ÷ (management investment ÷ management's share). On an illustrative buyout where the sponsor invests 197.5 for 80 per cent and management 2.5 for 20 per cent, the sponsor is paying 246.9 for the company's equity and management 12.5: an envy ratio of 19.8x, even though both buy their ordinary shares at the same 1.00 a share.
Worked in full in The Buyout Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The ratio exists because in most buyouts the sponsor does not just buy shares. It writes an institutional strip: a small slice of ordinary shares and a much larger slice of shareholder loan notes or preference shares carrying a fixed return. Management buys only ordinary shares, its sweet equity. Same price per share, very different price for the equity as a whole.
| Input | Value |
|---|---|
| Sponsor loan notes | 187.5 |
| Sponsor ordinary shares | 10.0 |
| Management ordinary shares | 2.5 |
| Total equity funding | 200.0 |
| Loan note coupon, compounding | 10% |
| Holding period | 5 years |
| Exit equity value (after bank debt) | 450.0 |
The ordinary share capital is 12.5, all issued at 1.00 a share. The sponsor holds 80 per cent of it and management 20 per cent. Measured by money, the picture is the opposite: the sponsor provides 98.8 per cent of the funding and management 1.25 per cent.
Step 1: the price each side pays for 100 per cent. Divide what each party invests in total by the share of the ordinary equity it receives.
Sponsor: 197.5 ÷ 80% = 246.9
Management: 2.5 ÷ 20% = 12.5
Envy ratio = 246.9 ÷ 12.5 = 19.8x
In Excel: =(SponsorTotal/SponsorPct)/(MgmtTotal/MgmtPct). The sponsor total must include the loan notes: they are 94.9 per cent of its strip.
Step 2: what the loan notes take at exit. At 10 per cent compounded for five years, the notes grow by a factor of 1.61051:
Loan notes at exit = 187.5 × 1.15 = 302.0
Ordinary equity = 450.0 − 302.0 = 148.0
Step 3: split the proceeds. The sponsor receives the notes plus 80 per cent of the ordinary; management receives 20 per cent of the ordinary.
| Party | Invested | Proceeds | MOIC | IRR |
|---|---|---|---|---|
| Sponsor (strip) | 197.5 | 420.4 | 2.13x | 16.3% |
| Management (sweet equity) | 2.5 | 29.6 | 11.84x | 63.9% |
| Total | 200.0 | 450.0 |
Management put in 1.25 per cent of the money and takes 6.6 per cent of the exit proceeds and 10.8 per cent of the 250.0 gain. That is the point of the structure: the loan notes take a fixed return, so every unit of value above 302.0 goes to the ordinary shares, of which management owns a fifth for almost nothing. The ordinary shares of both parties rise 11.84 times; the sponsor's blended multiple is only 2.13x because 94.9 per cent of its money sits in notes capped at 10 per cent a year.
The other side of the leverage is just as sharp. Below an exit equity of 302.0 the ordinary shares are worthless and management loses everything, while the sponsor still recovers its notes. Management gets its 2.5 back only at an exit equity of 314.5.
| Exit equity | Ordinary value | Sponsor | Sponsor MOIC | Management | Management MOIC |
|---|---|---|---|---|---|
| 250 | 0.0 | 250.0 | 1.27x | 0.0 | 0.00x |
| 300 | 0.0 | 300.0 | 1.52x | 0.0 | 0.00x |
| 350 | 48.0 | 340.4 | 1.72x | 9.6 | 3.84x |
| 400 | 98.0 | 380.4 | 1.93x | 19.6 | 7.84x |
| 450 | 148.0 | 420.4 | 2.13x | 29.6 | 11.84x |
| 500 | 198.0 | 460.4 | 2.33x | 39.6 | 15.84x |
| 600 | 298.0 | 540.4 | 2.74x | 59.6 | 23.84x |
Each extra 50.0 of exit value adds 10.0 to management, four turns of its cheque, and 40.0 to the sponsor, about a fifth of a turn of its own.
Keep management's cheque at 2.5 and the price per ordinary share at 1.00, and move more of the sponsor's 197.5 from notes into ordinary shares. Management's stake and the envy ratio both fall:
| Sponsor ordinary | Loan notes | Management stake | Envy ratio | Management proceeds | Management MOIC | Sponsor MOIC |
|---|---|---|---|---|---|---|
| 10.0 | 187.5 | 20.0% | 19.8x | 29.6 | 11.8x | 2.13x |
| 20.0 | 177.5 | 11.1% | 9.9x | 18.2 | 7.3x | 2.19x |
| 40.0 | 157.5 | 5.9% | 4.9x | 11.5 | 4.6x | 2.22x |
The envy ratio is therefore the lever the sponsor actually negotiates with: management's cheque is usually fixed by what the team can afford, and the strip ratio decides what that cheque buys.
The coupon on the notes works in the same direction. A higher rate raises the hurdle the ordinary shares must clear before they are worth anything, without changing the envy ratio at all, which is why the two must be read together.
Divide each side's total investment by its share of the ordinary equity, and compare the two prices. Here 246.9 against 12.5 gives 19.8x: management turns 2.5 into 29.6 at the base exit and into nothing below 302.0. The exit waterfall of a full buyout, including the option pool, is laid out in the free workbook for this book.
There is no fixed answer: it is a negotiated output, not a market constant. What matters is what it delivers. In the illustrative case an envy ratio of 19.8x gives management 11.84x and the sponsor 2.13x at the base exit, but management is wiped out below an exit equity value of 302.0, so a high ratio buys a steep, all-or-nothing incentive.
Usually for tax reasons: shares bought at the same price per share as the institutional investor are easier to defend as acquired at market value. The advantage is delivered instead by the strip: the sponsor puts 187.5 of its 197.5 into loan notes that carry a fixed 10 per cent coupon and take no share of the upside.
The coupon accrues ahead of the ordinary shares, so a higher rate leaves less for them. At 10 per cent compounded for five years the 187.5 of notes grow to 302.0, and that is the hurdle management must clear before its shares are worth anything. Management only recovers its 2.5 at an exit equity value of 314.5.
This article is one calculation from The Buyout Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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