Today we’re going to talk about the importance of placing participating caps on all participating preferred securities and why they will help protect common shareholders.
Why Participating Caps?
Okay, so you’re a CEO of a startup and your business is growing rapidly. Investors are lining up to fund your next round at a much higher valuation. All you need to do is select the investors that will give you the most money at the highest valuation, right? Not so fast.
If you’re a CEO that’s fortunate enough to find themselves in this position. You will need to navigate several potential obstacles. Like all things, it’s never quite as simple as it seems. Today we’re going to talk about the importance of placing participating caps on all participating preferred securities and why they will help protect common shareholders.
So what is participating preferred? Put simply, participating preferred is a type of security, senior to common equity, that will typically have a liquidation preference to be paid out before any funds are distributed to common shareholders (click here for a greater explanation of securities). Once the participating preferred receives its liquidation preference, their shares will participate (alongside common shareholders) in all the remaining proceeds.
What is the purpose of participating caps?
Participating caps simply limits the amount a preferred equity holder can receive on proceeds in excess of its liquidation preference.
As you can see, placing participating caps on participating preferred securities is beneficial to common shareholders. Since the founders/management are typically common shareholders, caps will help ensure their equity has value. This is critical as it further incentivizes employees and aligns their interests with that of the business.