Who Owns The Company Here?

Guys. A hypothetical situation is described below. Assume the capital structure of a company at T = 0 (right when the PE firm made its investment is the follows)

Senior Debt = $200
Sub Debt = $100
Pref Equity (all of which is bought by the PE sponsor) = 50
Common Stock = $50 (of which 40 is attributable to management, and 10 to PE sponsor)

Let's also assume that the Pref cannot be converted to common stock, and only has a 2.0x liquidation preference. In this situation, is the owner of the company the management (40 / 50) i.e. 80% or is it still the sponsor ( [50 + 10] / [50+50]) implying 60%?  In other words, when calculating ownership %, are preferred equity and common equity lumped together? 

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Comments (8)

Sep 4, 2020 - 11:22am

The latter - typically pref. equity comprises the majority of the sponsors equity capital as this has a more senior claim than management (who hold shares at the ordinary level).

Sponsors can structure it such that they have a split between preferred and ordinary as you have exampled.

Sponsor is majority owner here.

  • Associate 1 in PE - LBOs
Sep 4, 2020 - 11:43am

I get your point but I thought the second ownership structure would result only when sponsor's pref shares were convertible to common? In my example above, I assume that the pref is not convertible. I am confused then how would the ownership structure differ in the event where pref is convertible and vice versa. 

  • Associate 1 in PE - LBOs
Sep 4, 2020 - 2:01pm

I know that the PE sponsor controls the company and will seek voting rights. What I mean by "ownership" is how will the economics of returns be allocated among the management team and sponsor in the case where pref is convertible and where pref is non-convertible. Thank you for engaging.  

Sep 4, 2020 - 2:45pm

If the pref shares vote like commons, then the sponsor controls the business.

For most exit scenarios, the sponsor will own the majority of the proceeds.

For example, if the business sells for $500. Creditors get $300, so there are $200 of distributable proceeds. The sponsor gets the first $100 of equity value out from the pref, and then 20% of the commons. So the sponsor gets $120 and management gets $80.

At increased exit values, the management team would own a majority of the proceeds.

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  • Associate 1 in PE - LBOs
Sep 4, 2020 - 2:50pm

Thanks very much, Leon Black. Very helpful. All clear. Quick follow-up: you wrote, "if the pref shares vote like commons, then sponsor controls the business". What other ways can the pref vote? 

Sep 4, 2020 - 3:03pm

If there are 100 shares (50/50 pref/common), then the group with 60 would have the most votes. 

Different classes of shares can have different voting rules. PE firms usually negotiate the class of share they own have some sort of pref on the economics (participating; liq pref; etc), and usually additional positive/negative controls that have implications on your general question of "control".

Venture is full of scenarios like your description where the pref shares are non-voting, and just come with economic benefit. The VC may just get the liq pref and own 20% of the commons with pro rata board representation (1 out of 5 board seats, for example). While they wouldn't "control" the business, their share class and shareholder agreement will probably mean that they have to approve the operating budget, have step-in rights for management (e.g. fire CEO), have the right to force the company to sell (drag-along/tag-along), etc. So they don't really have "control" on paper, but they can exert way more influence than a 20% common shareholder.

In summary, it depends. Read the legals and you'll have a better sense of the answer. 

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