Question

If you were an entrepreneur, how would you think of the difference between a preferred-plus-cheap common structure and a convertible preferred structure?

Answer 1

First, the entrepreneur needs to gauge which of the two is more expensive to them supported by their assumptions of exit timing.

Secondly, the entrepreneur needs to take a look at the structural features. In the preferred-plus-cheap common structure one is talking about a redeemable preferred stock (with no conversion feature) which is then coupled with cheap common against a convertible preferred.   Redeemable preferred, as the name suggests, will have a redemption feature in the absence of the conversion right.

Some of the questions the entrepreneur needs to answer are:

1. Are you comfortable with the redemption option?
2. Are you at ease with the timing of the redemption?
3. What happens if entrepreneur is not able to redeem the preferred feature on the redemption date?
4. Does the redemption feature also have a cash pay preferred dividend?
5. Is there a possibility of derailing the business by redirecting cash to redemption of the preferred when it comes due - is the risk worth taking?
   

Therefore, the entrepreneur must answer these questions before he decides on whether to go for the preferred-plus-cheap common structure or the convertible feature.