For a fund looking to make a preferred equity investment, what are all the factors to consider? I assume a growing industry, experienced management team, etc are important, but is there anything specific to a preferred equity investment? This analysis is new to me, so I appreciate any and all responses.
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A lot of funds actually invest preferred equity in companies, as opposed to common stock. Its very common - private equity firms prefer to invest in preferred stock so in the case of failure, they rank ahead of ordinary shareholders. A coupon payment is often included, but even without a coupon the subordination mitigates some risk for the investor. Inherently, this is a protection mechanism for the private equity firm.
As far as the qualitative analysis, its the SAME. We make primarily preferred investments and look at the same drivers - recurring revenue, strong stable cash flows and EBITDA margins, sticky customer relationships, a degree of leverage we can work with, strong management team, mature industry with growth potential, and importantly a viable exit opportunity (critical in this environment). These are all characteristics of a traditional LBO candidate.
As the name suggests, preferred equity is like regular equity...but with preferred terms. The primary consideration with preferred equity is what the seller and other shareholders will allow you to structure (for example, if other shareholders would hold common stock that is junior to your preferred). Preferred equity can enhance returns and mitigate risk, so those terms are factored into any returns analysis. There is nothing special about making a preferred equity investment versus a regular equity investment - preferred equity is simply a tool with which you can better protect downside and/or enhance upside.
Thanks for the responses.
Regarding cash inflows / outflows for a preferred equity investment, am I thinking about this correctly?
Example: $100 pref w/ 10% dividends and warrants convertible into 5% of equity on a fully diluted basis Initial Investment: ($100) Annual Dividend: $10 Year @ Exit: $100 + 5% of equity value
Interested in this as well
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