How preferred equity is structured
Preferred equity is documented as an equity interest with a priority return, typically 9 to 14 percent, paid current, accrued, or a blend, ahead of any common equity distributions. The preferred equity holder may also share in residual upside above defined hurdles, or may accept a fixed return with no equity participation.
Because preferred equity is technically equity (not debt), it does not require the senior lender's mezzanine intercreditor agreement, which makes it deployable in situations where the senior lender will not permit mezzanine debt.
When preferred equity is the right tool
Preferred equity is most commonly used in these situations:
- Senior lender prohibits mezzanine debt but will permit preferred equity
- Recapitalization that buys out an existing equity partner without refinancing the senior
- Construction stack requiring incremental capital between senior and common equity
- Acquisition with an under-equitized sponsor seeking minority capital partner
- Rescue capital for over-levered assets approaching maturity
Representative preferred equity terms
Preferred equity pricing reflects the structurally subordinate position.
- Investment size: $3M to $150M+
- Pricing: 9% to 14% preferred return, current pay plus accrued
- Participation: fixed return or preferred return plus residual share above hurdles
- Hold: 2 to 10 years, typically aligned with the business plan
- Control: limited consent rights on major decisions; force majeure remedies on payment defaults
FAQ
Frequently asked questions
- What is the difference between preferred equity and mezzanine debt?
- Preferred equity is an equity investment with priority distributions, no foreclosure remedies, and no requirement for a senior lender intercreditor agreement. Mezzanine debt is a loan secured by a pledge of equity interests, with UCC foreclosure remedies and a required intercreditor agreement with the senior lender. Preferred equity is structurally junior to mezzanine debt when both exist in the same stack.
- Does preferred equity require senior lender approval?
- Most senior lenders allow preferred equity at the holding-entity level without intercreditor consent, particularly when structured as a passive equity investment without control or removal rights. Preferred equity at the borrower-entity level often requires senior lender notice and may require limited consent rights to be modified.
- What is the typical return on preferred equity?
- Preferred equity pricing typically ranges from 9 percent to 14 percent preferred return, current pay, accrued, or a blend, with optional participation in residual upside above defined hurdles. Fixed-return preferred equity (with no participation) prices toward the upper end of the range.
- Can preferred equity replace mezzanine debt in a capital stack?
- Yes, frequently. Preferred equity is often used in place of mezzanine debt when the senior lender will not permit mezzanine debt, when the sponsor wants to avoid an intercreditor agreement, or when the equity partner prefers an equity position to a debt position for tax or balance-sheet reasons.
- How is preferred equity treated by lenders and accountants?
- Lenders generally treat preferred equity as equity for senior loan compliance, it does not count against the senior's leverage tests or restrictions on subordinate debt. Accounting treatment depends on the specific preferred equity terms, including whether the return is mandatorily redeemable; sponsors should consult their accountants on classification.