Preferred equity vs common equity?
Why would someone raise common equity over preferred equity? If you hypothetically thought your deal was going to be a home-run, if you could raise the gap in your capital stack as preferred equity and retain all the upside for yourself, why wouldn't you do that? Maybe the answer is, "you would". Can someone but can someone explain how the dynamic that plays out in the real world in terms of when deals are funded with preferred equity investment vs traditional equity?
There’s nuance to the decision beyond just the consideration of upside at exit that you mention. You’re right, all else being equal, filling the cap stack with common LP equity allows for upside retention since preferred equity (without ups/warrants) is just structured paper that pays current and/or accrues to at least a minimum multiple most commonly.
That being said, there are other considerations to think about. For example, for certain development projects, a developer (the GP) may want to fund pari with common LP equity rather than funding their equity first, followed by the pref, followed by the senior. Secondly, consider a longer construction timeline (36 months) and stabilization schedule where the preferred equity is accruing. A developer may want to “de-risk” this basis accretion by raising common LP equity with a first waterfall hurdle much lower than the all-in preferred accrual rate.
There’s also control & consent rights and guarantor (carry, completion, interest) considerations vis a vis preferred equity vs common LP equity.
The situation I am imagining where you want to hold an asset indefinitely, and are able to return capital through refinance relatively quickly, to me this seems like a scenario where preferred equity would be a no brainer. You're paying a higher price for that money in the short term, but after that the rest of the cash is yours in perpetuity. Am I missing something?
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