Where you invest plays a big role in building long-term wealth, which means choosing the right option can greatly increase the value of your portfolio. If you ever took any interest in the stock market, you should be familiar with Preferred equity. It is one of the most commonly opted choices for earning dividends. On the other hand, structured equity is a less known option, but it’s gaining popularity with time and for good reasons.
Both these options offer different advantages and risks, and that’s what we are going to list and explain in this post. We will help you understand what both options provide to an investor to help you make a better decision. Let’s start with some basic definitions.
Structured Equity
Structured equity is a hybrid and customizable financial tool that helps businesses raise capital through the market. This hybrid tool consists of debt and equity features; they offer the growth of equity and the security features from debt agreements.
The flexible nature of structured equity makes it more beneficial for both parties and allows the owner to keep the power of authority within the firm for some time. Structured equity offers moderate growth and less risk for investors.
READ MORE Structured Equity 101: What Investors Should Understand
Preferred Equity
Preferred equity is similar to traditional equity, where you invest in a stock and acquire a direct stake in the company. However, preferred equity has certain advantages over common equity holders. Preferred equity holders are priority investors who receive fixed and regular dividends before common equity holders. They are also the priority in the event of company liquidation, which means preferred shareholders are the first to get paid if the company collapses.
In contrast to common equity, preferred equity holders don’t have the right to vote in company decisions. This makes preferred equity an option for people who want regular secondary income without being included in management decisions.
Structured Equity Vs. Preferred Equity
1. Risk and Return Profiles
Structured equity, in general, offers less risk because of its mixed features and flexible nature, but when compared with preferred equity, this type of equity is considered more risky. Both options provide returns based on the company’s performance, which means if the company performs well, the stock prices will rise, giving better returns and vice versa.
Preferred equity is considered less risky here because of the dividend and priority system. Preferred equity holders are the company’s priority investors, meaning they are the first to get paid. They also receive fixed dividends and are the first to get paid if the company is being liquidated, making it a lot less risky than structured equity.
2. Investment Flexibility
Structured equity shines the brightest among all investment options regarding flexibility. The customizable nature of the equity makes it beneficial for the investors and the company. Investors can add points to the agreement that would benefit and suit their style; if you don’t want to be a part of management decisions, you can add it, and you can even switch to equity later with more influence over management decisions. You can even decide the payment terms and when to be paid.
Compared to structured equity, preferred equity terms are more rigid. The contract terms are preset and have no scope for change due to changing market circumstances. It may provide predictability but not flexibility.
READ MORE 7 Key Differences Between Structured Equity and Traditional Equity Every Investor Should Know
3. Return Potential
Structured equity also takes it up when it comes to returns. It offers a company performance-based return, which means the returns can go higher than what preferred equity provides. Even though the returns are capped at a specific point, long-term returns are better than the other.
For preferred equity, returns aren’t the main concern; it’s an investment option that is more dividend-focused. Preferred equity holders are people who want regular and fixed income, not long-term growth.
4. Priority in Capital Structure
If the company goes bankrupt or collapses, structured equity holders are in the middle of the line to get repaid after liquidation. They come after senior debt lenders and preferred equity holders, which puts the position at risk of not getting paid.
On the other hand, preferred equity holders are priority clients for the company who get paid right after senior debt lenders, making this position much less risky when compared to other options.
5. Ownership and Dilution
Structured equity is designed to protect the ownership dilution. Most of the time, investors are given equity-like returns without any ownership rights. However, with its customizable terms, investors who wish to have some control are provided with certain rights. Additionally, if the equity is convertible into common shares, investors who want more control and ownership can switch, diluting the firm’s ownership.
Preferred equity holders have no rights or significant ownership control in the firm. Even for ownership dilution, preferred equity tends to be less dilutive than common equity.
6. Control and Voting Rights
Structured equity is designed for companies that want to preserve the power of decision-making within the company. However, its flexible nature may allow some investors who wish to have a say in some decisions to have some control over these decisions. Moreover, once the company has gone public, the firm cannot maintain the same for a long time; investors can convert their structure equity into traditional equity if they wish to gain more control over company decisions.
Preferred equity holders also don’t have any control or voting rights in the company. Very few investors, under special circumstances, are allowed to vote, but their votes are not as influential as those of common shareholders. It can be a downside for people who want to be more included in company decisions.
7. Costs and Terms
Structured equity offers higher potential returns than preferred equity because of the mixed debt and equity elements, making the contract more complex. The cost of customizing the contract to meet specific risk profiles must also be added. Therefore, it becomes more expensive due to its complexity and custom risk premium.
Preferred equity takes this round with its straightforward terms. Preferred equity is more cost-effective than structured equity because of the straightforward terms and obligations.
Frequently Asked Questions (FAQs)
Is preferred equity structured equity?
No, preferred equity and structured equity are two different investment options. Preferred equity is more income-focused and has a higher claim on assets, whereas structured equity is a mix of debt and equity, which is more growth-focused with less risk.
What are structured equities?
Structured equities are a hybrid financial tool that helps firms raise capital and provide equity and debt features.
What is the difference between equity and preferred equity?
The main difference between traditional equity and preferred equity is that preferred equity holders receive regular fixed income in the form of dividends and have higher claims on company assets. In contrast, traditional equity offers more firm control in a company’s decision-making.
What is preferred equity?
Preferred equity is a class of ownership in a company that offers the shareholder more priority over another common shareholder when receiving the payment. It also offers fixed dividend income and higher claims on company assets.
Final Statement
Both structured equity and preferred equity are designed to cater to different types of investors. You have to understand which options sound more like something that can help you reach your investment goal.
Structured equity offers you growth, flexibility, the potential for higher returns, and the chance to convert your equity into traditional equity if you wish to have more voting influence. But it comes at the expense of higher costs, added risks and complexities. For preferred equity, you get more stability, fixed income, and first claim on assets, but you will have no control over the firm’s decisions.
People looking for a growth-based option should lean towards structured equity, while people looking to build a secondary source of income should opt for preferred equity. It’s your decision now; we have provided you with the information you need to make your own decisions. So, good luck, and Happy investing.
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