Participating preferred question
Hi guys,
I have some questions with regards to pref shares.
Say company A raises $100m in participating preferred shares with 7y maturity, PIK interest and 5% equity (ie: company valued at $ 2bn)
- are these preferred shares accounted for as equity?
- How does one value these preferred shares? (they are basically a form of PIK note with warrants aren't they?)
- do they have an impact on the value of the common shares?
Thanks!
Preferred shares in this case would be treated as equity, but are senior in preference to the common in terms of the liquidation waterfall (need to pay back $100mm in principal plus accrued interest ("liquidation preference") before the common starts sharing in proceeds). As this is a participating preferred, there is no common "catch up" once the liquidation preference is cleared, and the participating preferred will start sharing in the remaining proceeds on an "as converted" basis (5% of proceeds available to common).
In terms of valuation, it will be dependent on the total company equity valuation as well as the liquidation waterfall. If there are any junior preferred securities junior to this one, they would receive their own liquidation preferences before common shareholders get any proceeds (which the participating preferred shares in).
For example, at a $4bn equity valuation, the participating preferred would receive their $100mm principal (plus accrued interest), then 5% of the remaining proceeds (5% * $3.9bn = $195mm) for a total of $295mm.
Sb'ed for the succinct explanation
Crystal clear, thanks for the explanation SushiShop!
Interesting that they are still considered "equity" when they have a redemption feature at year 7. These instruments really marry capital protection with all of the upside potential well!
Quick questions if you have time please:
How would their addition to the capital structure affect valuation? (I assume the pref will be issued at a par of 100 per share for a total of $100m, ie: 1m new pref shares issued but what the impact of such an instrument on the share price?)
Would the accrued dividends (unpaid) generally convert into equity in case of a trade sale/IPO or is paid out in cash and the pref shares investors is only entitled to the 5% of the net proceeds?
Are there any good material available to read on that topic?
Thanks!
You are correct on the valuation. The $100mm of new primary capital would add $100mm of cash to the balance sheet and therefore $100mm to the enterprise value. In this example, the pre-money valuation is $1.9bn and the post-money is $2.0bn.
On the dividends, yes the accrued dividends would increase the participating preferred share count (and the liquidation preference) and in a trade sale they would receive the proceeds attributable all of those shares (liquidation preference plus 5% of remaining proceeds). In an IPO, the participating preferred would receive its liquidation preference (which includes the accrued dividends) immediately as part of the use of proceeds, and they would also receive common stock on an as converted basis (at least 5% including dividend shares), which would be subject to standard lock-up provisions etc.
This link explains it pretty well: https://www.vcexperts.com/reference/encyclopedia/chapters/slug/particip…
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