Preferred shares are a class of equity that blend characteristics of both stocks and bonds. While they represent ownership in a company like common shares, they typically come with fixed dividends, liquidation priority, and other rights that offer enhanced protections for investors. In private offerings—especially those under Regulation D, Regulation A+, or venture financings—preferred shares are often used to attract early capital by offering investors stronger upside potential with downside safeguards.
Understanding how preferred shares work is key to evaluating private investments, particularly when weighing risk, expected return, and exit strategies.
What Are Preferred Shares?
Preferred shares are equity securities that sit between common stock and debt on the capital stack. Investors holding preferred shares typically receive:
- Priority Dividends: A fixed return paid before any dividends are issued to common shareholders.
- Liquidation Preference: In the event of a sale, merger, or liquidation, preferred shareholders are paid out before common equity holders.
- Conversion Rights: Some preferred shares can be converted into common stock—often during a company’s IPO or acquisition.
- Anti-Dilution Protections: Safeguards against future rounds of financing at lower valuations.
- Voting or Board Rights: In some cases, preferred shareholders may have voting rights or the ability to appoint directors.
These features are negotiated during private offerings and vary by issuer, round, and investor class.
Where Preferred Shares Are Used
Preferred shares are a common fixture in:
- Startup Financing: Used in seed, Series A, B, and beyond to attract venture investors.
- Regulation A+ Offerings: Issuers often use preferred shares to make offerings more attractive to retail investors by offering dividends or liquidation preferences.
- Real Estate Syndications: Preferred equity may be used to give investors fixed income and return of capital priority.
- Private Placements (Reg D): Structured offerings frequently include preferred shares with negotiated rights tailored to the investor profile.
Each use case reflects a desire to offer more than just speculative upside—especially when companies are pre-profit or cash-constrained.
Benefits for Investors
Preferred shares offer several key advantages in private markets:
- Income Potential: Many preferred shares offer fixed dividends (e.g., 6%–10% annually).
- Downside Protection: Liquidation preference helps protect invested capital in a downside event.
- Enhanced Terms: May include redemption rights, participation in future upside, or bonus equity.
- Earlier Exit Path: Preferred shareholders may be bought out in secondary sales or financing rounds.
This makes preferred shares appealing for investors seeking a mix of income and capital appreciation.
Risks and Considerations
Despite their benefits, preferred shares carry risk:
- Lack of Liquidity: As with most private investments, preferred shares are often illiquid.
- No Guaranteed Dividends: Payments depend on the company’s financial condition.
- Complexity: Terms vary widely, and investor protections must be carefully reviewed.
- Subordination to Debt: In liquidation, preferred shares still rank below lenders.
Investors should evaluate offering documents and capitalization tables to understand where their rights sit relative to other stakeholders.
Preferred shares offer a compelling alternative for private investors who want more than speculative common equity. With potential for income, protection, and priority, they’re a strategic tool in private markets—used by companies to align investor expectations with capital needs. For investors who seek returns with reduced downside exposure, preferred shares can be a valuable part of a private market portfolio.
