The Direct Private Investments Show
Securities Structures
Timestamps:

[00:00:32 The importance of security structures in direct private 
investments   
[00:02:30] – Types of equity investments: Preferred Stock   
[00:04:13 – 05:29] - The role of participating convertible and convertible  
preferred stock
[00:05:29 – 10:55? Guiding investors regarding security structures  
[10:55  17:22 Key elements in debt structures 
(22:32 – 26:00 Equity hold periods and exit multiples
 
Introduction:

Two fruits. Both are round, but each delivers an entirely different taste

sensation and benefits to your palate.

In a recent episode of the Direct Private Investments Show, proudly
presented to you by Carofin, Matt Brown interviews Bruce Roberts and
Garrick Ruiz about the two primary categories of private investments, debt
and equity. This article draws upon the interview to help investors to
understand how each investment is structured and the different benefits and
risks each pose.

Securities Structures

As investors diversify their portfolios with direct investments, they should
ensure that the investment structures align with their goals, whether debt or
equity. Specialist funds are often created to manage these types of
investments, as they require different approaches to ensure a suitable
structure both for the investors and the companies in which the investments
are made. You can review a white paper called Understanding Private
Securities here for a moredetailed explanation.

Equity

Equity investments, higher-risk securities than loans, offer preferred stock
which is junior to debt but senior to common stock. Often depending upon
the stage of a company, it may offer different types of
preferred stock, such as a participating preferred. Here, investors continue to
participate in profit distributions of the Issuer as common shareholders after
they have received a full return of their invested capital and any other
preferred distributions to which they are entitled.

On the other hand, the equity being offered might be a convertible preferred.
This form allows investors to receive dividends and to convert their shares into
common stock at a fixed conversion ratio after a specified time, participating
pro-rata with common stock.

Debt

Debt investments are comprised of three key elements: its maturity, interest
rate, and the source of repayment. Maturity refers to the moment when the
final principal payment for a debt obligation must be paid by the
borrower/Issuer. Debt investments are generally shorter-term investments
than equity and are designed with a current income component that is
usually accompanied by an amortization schedule. These payments reduce
investors’ exposure to the industry and the risk associated with the
investment as the remaining principal is reduced, usually on a monthly basis.

As interest rates fluctuate, investors are likely to compare what is called the
risk-free rate – that is, the interest an investor would expect from an
absolutely risk-free investment over a specified period of time – to the rate
being offered by a private debt investment. An investor should do this
comparison to decide whether the rate being offered is commensurate with
the risks the private debt represents.
The sources of repayment for debt investments can vary. Some will be from
the company’s cash flow. While a preferred solution, it never hurts to
augment the security’s source of repayment with additional sources, such as
readily sellable collateral and even a personal guarantee from
the company’s owner. These may be attached to protect investors and help
them recover their investment in case of a default (see Private Lending to
Operating Companies here for more context and a description of other forms
of debt).

Guiding Investors

Investors, when considering private placements, should take into account
their liquidity needs and risk tolerance. More conservative investors – or those
with shorter-term liquidity needs – may find debt investments more suitable.
Investors with higher risk tolerances and longer investment horizons might
feel comfortable with equity investments, which offer the potential for higher
returns over time.

Conclusion

Understanding the security structures of direct private investments is
crucial for investors to ensure alignment with their goals, risk tolerance and
need for diversification.

While we’re not talking about fruit, each delivers an entirely different “taste”
to your portfolio. By spreading investments across different asset classes,
investors can mitigate risks and potentially increase their returns.

Watch the full episode above and, if you’d like to sample our offerings, feel free to peruse them here.

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