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I assume you know the reasons why participating preferred would be used over straight common? You're more likely to see the structure used by mezz funds, and I guess uni funds, as well. Some PE firms open to non-control situations would consider the structure, too. In any case, I have never seen a firm with participating preferred as a KEY strategy for their portfolio.
Yea, was just curious. I realize the reasons why it would be used over straight common or even warrants/convertible. I figured there wouldn't be many (if any) firms that use it as a key strategy, but always find myself surprised still, given the amount of funds and money out there (esp. in the MM).
It's a way to bridge the valuation gap and is more common in growth equity/minority equity infusion scenario's. You are effectively lowering the pre-money valuation when compared to a straight preferred security. More likely to see it in the lower MM.
EightAceTres hit the nail on the head. I've used the structure, and it is a terrific way to protect on the downside when valuation is an issue. Basically, until the PE firm gets the face value of the Preferred plus any accrued dividends, the seller (or holder of common shares) gets nothing. After the preferred is paid off, the remaining proceeds are split pro rata between the common shareholders. Typically, the PE firm woud have 100% of the preferred and a portion of the common to bridge the gap between the return from preferred dividends, and the target return on equity.
Ok, I understand how it works (good explanations though), I was inquiring about groups that actually use it semi-regularly as one of its strategies.
EightAceTres or Schrute... how often would your/other firms use it?
From my experience it's not used often, and I never saw an LOI with the structure when I was in banking. As others have said, its used in situations where value expectations are not aligned. I'm sure every PE firm would love to use the structure on more deals (given downside protection), but most sellers are / can be convinced that a little less money up front with a greater roll percentage, is actually worth more in the long run.
Thanks. Makes sense.
We would propose it in our initial TS, and if we got some negative feedback would either lower the preference, the dividend, or a combination of both. This was more common with companies with rapid growth projections, and thus a higher sense of value than what most investors could justify.
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