When it comes to running or starting a business, there are several factors to try and secure capital/finances, and all of them likely cost more money than you happen to have on hand to personally finance.
Luckily, some options and programs exist to help with the necessity of expensive startup costs, so that you don’t have to overdraw your accounts and clean out your savings to purchase things you need.
One of these things is preferred equity lending.
Preferred Equity Lending: A Definition
The easiest way to look at preferred equity lending is to describe it as a specific structure that is in place for businesses to more easily be able to finance their need for commercial real estate.
To look at it another way, preferred equity is a specific type of financial capital that will put a private lender in a position where they will be the first to receive their repayment from any profit of cash flow that any investment they have a stake in has earned. They will receive their payment first before any others who might also have a stake in the investment.
This is to prevent them from incurring undue risk when it comes to them lending their money. Basically, similar to some other investment methods, if a lender becomes a preferred equity lender, they will have a larger importance/status when it comes to common equity investors and common shareholders.
Keep in mind that, if you’re worried about the risk that you might be under with this sort of lending method, there isn’t a great way to determine how much at risk you will or won’t be. This is because you’ll be put in a position where you have a specific amount of money that is lent to you (potentially from different sources), but you will then need to pay it back in a specific order – the preferred equity lender first and foremost.
This means that if your business ends up not performing as well as you would like it to, you will not be able to pay your investors back in the specific order you want.
Common Equity vs. Preferred Equity
Keep in mind that common equity and preferred equity are different things. Make sure you know the difference so that you don’t become confused!
As mentioned, preferred equity investments are those that offer lenders the highest possibility of receiving a return on their investment. This type of equity results in borrowers receiving supplemental capital that they can use alongside other loans. However, a preferred equity loan places a lower priority on certain investors than a traditional lender would.
Common equity, on the other hand, follows after preferred equity holders. At the point that common equity holders who have given funding are expecting to be repaid, the preferred equity holders have already received their money. The common holders (those who have skin in the game, as it were) will be paid equally from whatever profit or cash flow remains.
As a borrower, knowing the types of lending options you have access to will help you determine the best methods for finding funding for your business. Whether you’re starting out or in the middle of running your business, do your research and choose what is best for you.