Co-Investing Deal Structure (EXAMPLE)

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Have you guys ever seen a deal where the equity partners have co-invested in the form where one invests 50% of equity as preferred (with a 10% coupon cumulative) and the remainder covered by the other partner as common stock? Let's say that the equity partner providing the common is in the process of fundraising and brought it in a partner to augment the funding channel (in this case preferred equity partner). Assume that the fundraising is successful and the common guys want to buy up the preferred stake in a year's time (pay off the principal and whatever interest had accrued till then) and take up 100% ownership of the business. Is this a common scenario/play for a fund that is in fundraising but doesn't have funds yet to cover the equity? Even if it is not a common scenario, as it currently is stated, do you guys see it as contentious for the guys providing pref financing --- they won't be keen to agree to it?

Thanks

Comments (8)

 
  • Associate 1 in PE - LBOs
Jan 16, 2020 - 7:07pm

Anyone?

Array
 
Jan 17, 2020 - 8:36am

I can't speak to whether it is "common" or not, but to answer some of your questions based on my perspectives.

1) Is this a common scenario/play for a fund that is in fundraising but doesn't have funds yet to cover the equity? - Here is a scenario where I think you'd see this play out. Someone finds a great deal they want to do, but for one reason or another is struggling to raise the entire cap structure (debt and equity). Maybe the characteristics aren't attractive fromt the debt standpoint (cash flow, upside, asset base, etc.) and maybe potential equity investors don't see the upside as the individual who found the deal does. Along comes equity investor who can meet the capital need, but manages their risk by using a preferred instrument. Assuming the pref equity is participating, their downside is much more limited than the common (in a liquidiation event they would need to just clear the debt + their pref equity position). At the end of the day, it's another type of financing that fills an unmet need

2) Even if it is not a common scenario, as it currently is stated, do you guys see it as contentious for the guys providing pref financing --- they won't be keen to agree to it? - Depending on how it has been characterized, if it's participating upside, I don't think it would be too contentious. Now, the pref financer may be irratated if it's positioned to them as more perminant capital and they aren't supposed to get blown out in 1 year. This can be mitigated by incorporating some sort of premiums if it's called early, or additional investment rights.

 
Jan 17, 2020 - 2:29pm

Thanks, skyline. This is helpful. Just a quick follow up. say if the common ends up paying off the preferred at end of year 1 (upon fund raise) what would have been the total equity outflow from the common partners’ perspective. A very basic example below. Where is my calculation wrong - if at all? Thanks again

Pre-fund raise;
Pref 100 (10% interest compound)
Common 100

Post-fund raise (end of year 1) - common raises a 1bn fund, pays off the 110 due to pref and injects 100 (to cover the equity gap due to pref getting paid off) for total equity outflow of 310 (100 + 110 + 100 in one deal.

Is the math correct as per the scenario I’d outlined in my post?

Array
 
Jan 19, 2020 - 6:29pm

Your math is correct if the scenario requires to fill the amount previously held by the preferred. Or you can have the new investors fil the gap as part of the raise so the existing common doesn't have to put up more money.

Btw I'm not clear if you are talking about a fund, or talking about a specific deal. Not that it really matters too much.

 
Jan 19, 2020 - 8:44pm

It wouldn't really be "typical" in a traditional fund structure, so I asuume this is a seperate deal. I mean if they are going into the deal knowing they want to payout the preferred, then yes I would hope they have high conviction. If they are short on funding for the deal, which I assume is the case in this scenario, they could also seek out co-investors who would invest in the same security (common equity) and potentially charge them carry on that investment, thus bypassing the need for additional equity to take out the preferred slug mentioned in your example.

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