How would I model out returns on a security that has a 1x liquidation preference that is "reduced ratably to zero between 1.0x and 3.0x the initial investment price per share".
Can't seem to find this anywhere and I haven't done this before.
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What does that mean?
Typical participating preferred structure. If we invest $20 million for 20% fully diluted and total proceeds are $120 million, than return to investor is $20 million (liquidiation pref) plus 20% of remaining proceeds ($20 milllion) for a total return for $40 million. CoC return of 2x.
We structured a deal where our liqudiation preference is reduced from 100% to 0% as the price per share value increases from 1-3x cost.
I don't know how to reflect that variability in a proceeds to investor analysis.
You have to model it as a 3x cap with a sliding scale as if you gradually converted from preferred to common instead of all at once when you reach the 3x cap: Think of it as starting at 1x with 100% of your equity from your LP, 0% from your common distribution. Then as you move from a 1x return to a 3x return; your mix will slide from less $ from LP and more from common distribution, until you reach 3x where 100% of your $ comes from common shares.
The upside for common holders is that as returns go up from 1x to 3x, instead of converting pref to com at 3x all of the sudden, you'll do the equivalent of converting more and more to common as your returns go up starting at 1x. That's less LP in the way of the already common holders (management). Smart way to structure a deal on the mgt side -- never seen it but understand rationale.
If I were you, I'd try to lift it and put a straight 3x cap, more upside for you guys. If you still gotta model it, see above -- that's how i'd do it conceptually.
That makes perfect sense. I don't know why I didn't think of that.... Thanks.
Our rationale for the 1-3x is to avoid a kink in returns/keep management focused on a big exit for us. Obviously giving up some upside though.
Happy to help
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