Convertible Preferred Stock: How Preferred Is It? (Part Two of Two)

Convertible preferred stock investments provide important benefits for hedge funds and other investors including, among other things, a liquidation preference and the right to convert the investment into common stock of the company.  Nonetheless, an investor’s failure to rigorously negotiate a term sheet with respect to a convertible preferred stock investment before the specific charter provisions for the series are adopted can lead to inclusion of benefit-sabotaging terms that enable the company to leak value to the common stock while the convertible preferred remains outstanding; force conversion to occur sooner than the investor might like; and allow the preferred investor’s bargained-for terms to be amended away.  There are four principal areas of a company’s charter where the potential for value leakage, premature conversion or the loss of rights via amendment is most acute.  This is the second article in a two-part series identifying these risks and providing recommendations to assist investors in negotiating convertible preferred term sheets to fully capture the benefits of such investments.  The authors of this series are William Q. Orbe, founding partner of Richards Kibbe & Orbe LLP (RKO); Thao H.V. Do, a partner at RKO; and Catherine Rossouw, an associate at RKO.  See also “Convertible Preferred Stock: How Preferred Is It? (Part One of Two),” Hedge Fund Law Report, Vol. 6, No. 48 (Dec. 19, 2013).

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