Preferred equity is a type of investment that gives the holder priority over common equity shareholders in terms of receiving dividends and in the distribution of assets in the event of a company's liquidation. There are several different types of preferred equity, including the following:
- Cumulative preferred equity: This type of preferred equity requires any missed dividend payments to accumulate and be paid out before any payments are made to common shareholders. I've also build a preferred return model that prioritizes the dividend and allows for many configuration options regarding return of equity, compounding / accruing missed dividend payments.
- Non-cumulative preferred equity: Non-cumulative preferred equity does not accumulate missed dividend payments, and any missed payments are lost forever. For this option, I add a 'yes/no' selector in the joint venture models linked above to choose to start fresh each year or not. If 'yes', then any missed payments become lost.
- Convertible preferred equity: Convertible preferred equity can be converted into common equity at a predetermined price, giving the holder the potential for greater returns if the company performs well. I've actually not built a template for this yet, but I have done custom work for clients that had a convertible provision that needed implementing in the model.
- Participating preferred equity: This type of preferred equity allows holders to receive additional dividends if the company exceeds a certain level of profitability. In addition to receiving a fixed dividend payment, participating preferred shareholders receive a share of the company's profits beyond a certain threshold, before any profits are distributed to common shareholders.
- For example, if a company has issued participating preferred equity with a dividend rate of 8% and a participation rate of 2x, and the company's profits exceed a certain threshold, the participating preferred shareholder would receive a dividend payment of 8% of their investment, plus an additional 16% (2x the dividend rate) of the profits above the threshold, before any profits are distributed to common shareholders.
- Non-participating preferred equity: Non-participating preferred equity does not offer additional dividends beyond the fixed dividend rate.
- Callable preferred equity: Callable preferred equity gives the company the right to buy back the shares at a predetermined price.
- Perpetual preferred equity: Perpetual preferred equity has no maturity date and can remain outstanding indefinitely.
- Redeemable preferred equity: Redeemable preferred equity can be redeemed by the company at a predetermined price, giving the company greater flexibility in its capital structure.
Preferred equity is commonly used in a range of industries, including technology, healthcare, real estate, and energy. It is often used by companies that require long-term capital for growth, but don't want to dilute the ownership and control of the company by issuing more common shares. Preferred equity is also attractive to investors looking for higher returns than those offered by traditional debt securities, but with less risk than common equity investments.
Note, this can be modeled in many ways and the actual verbiage in the operating agreement for how the preferred equity gets structured is really important and can vary. Sometimes it may stipulate that 100% of the investors equity must be fully repaid + dividends before any cash goes anywhere else. Or it could be only stipulations regarding the preferred return due. There could be IRR hurdles as well.
