Third-Party Preferred Equity as a Financing Device: Structuring "Debt-Like" Equity

Companies are increasingly turning to third-party preferred equity to finance M&A and other transactions. PEIs are attractive to alternative credit providers because PEIs are priced to provide higher returns than traditional equity, but investors should be aware of the legal and structural differences between preferred equity and corporate debt.

Preferred equity holders may negotiate certain protections, such as the right to appoint directors or demand a sale of the issuer. However, they do not have the same rights as holders of debt to enforce payment and do not have the benefit of collateral, guarantees or the ability to act as a creditor in a troubled situation.

Counsel to prospective investors must be sensitive to how their client’s interests may differ from the company’s lenders and draft covenants that address investors’ rights and remedies. Preferred equity terms must also include protections against issuing equity that is pari passu and/or senior to the PEI being funded.

The coupon on a PEI can have drastically different tax attributes than interest on debt. The tax status of the issuer, the terms of the preferred equity, and the nature of the investor and its owners can determine whether a PEI can be structured in a manner that is viable from a tax perspective.

Listen as our authoritative panel examines the differences in terms, rights and remedies between PEIs and traditional debt. They will also discuss protective covenants private equity investors should consider when structuring the deal, and the tax treatment of debt as opposed to equity.

1. Preferred equity as an alternative to debt financing: Advantages and disadvantages
2. Structural differences between preferred and traditional equity
3. Key provisions and protective covenants
   1. Rights and remedies as compared to other debt holders
   2. Restrictions on issuance of competing debt and equity
   3. Power to appoint directors, dictate other corporate actions
   4. Redemption rights
4. Tax treatment of PEI returns vs. interest on debt

The panel will review these and other key issues:

• When is preferred equity an appropriate corporate finance option?
• What are the key differences between preferred equity and traditional debt?
• What kinds of covenants should be included to protect the PEI holder’s position in the capital stack and relative to the company’s lenders?
• How do tax considerations affect PEI structure?