What is an investor buying? - Shares or units representing ownership in a business. Preferred equity holders also receive additional rights and privileges that vary depending on the offering. Some potential privileges for preferred shares include investor priority in the event of liquidation of the company, voting rights, and anti-dilution provisions that could allow an investor to maintain their percentage ownership through future equity offerings.
How does an investor make money? - Investors make a return typically when, and if, the company is acquired by another company, or when the company has an IPO and its shares become tradable on an exchange. If the company raises money again by offering equity at a higher value, under some circumstances investors can sell their shares during the new offering.
What are the risks? - It may be very difficult to sell your shares. If it is not possible to sell your shares, the most likely exits for an investment are if the company is acquired by another company or decides to go public and list its shares on an exchange. It could take years before these options become possible for the company and most startups fail before they reach these goals. If the company is a private company, the amount of information it is required to disclose about its operations and plans can be limited. The limited amount of information available can make it difficult to accurately value the company and determine a fair price to pay for the investment. Investors also face a risk that a company may issue a large number of additional shares in the future which can dilute the investors ownership stake. Additional rights or privileges potentially assigned to preferred shareholders do not remove the risks of investment loss.
Why issue this? - Like common equity, preferred equity allows pre-revenue and revenue producing companies the opportunity to raise capital and offer investors the greatest potential return because of the high degree of risk. Preferred equity, by including additional rights and privileges, helps companies tailor offerings to attract specific types of investors, such as those who, for example, may want priority payment rights when the company is sold or IPOs, or more influence on their investment through the use of voting rights.