Glossary - Preferred Return
Preferred return refers to a priority profit distribution mechanism typically used in private equity and venture capital investments, where certain investors receive returns on their investment before others. It is often a fixed percentage that is paid to preferred shareholders or limited partners before any distribution of returns to common shareholders or general partners. This term is designed to protect investors by ensuring they receive a minimum level of return before the company's founders or other equity holders receive payments.
Also known as
- Hurdle Rate
- Pref Return
Use cases examples
- Limited Partnership Agreement: The Limited Partners shall receive a Preferred Return of 8% per annum on their contributed capital before any distributions are made to the General Partners.
- Shareholders Agreement: Preferred shareholders are entitled to an annual Preferred Return of 6%, payable semi-annually before any dividends are declared or paid on common shares.
Considerations for investors
- The preferred return rate should reflect the risk profile of the investment; higher risk investments typically warrant higher preferred returns.
- Mechanisms for recouping unpaid preferred returns, such as accruals or catch-up provisions, which could affect the timing and amount of distributions.
Considerations for founders
- Understanding the impact on cash flow, as ensuring preferred returns may require the company to prioritize certain financial obligations over others.
- The potential dilutive effect of preferred returns on common equity holders, especially in scenarios where returns are paid in additional shares rather than cash.
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