Preferred equity has moved from a niche instrument to a mainstream source of capital, and it is increasingly relevant to Irish deal-making.

Private equity sponsors have long used preference shares within their own buyout structures to return capital, set management incentive hurdles, or extract profits efficiently. What has changed is the emergence of a deep pool of external investors who provide preferred equity directly to operating companies as an asset class in its own right.

Those investors include private credit funds, dedicated structured equity funds, opportunistic and special-situations funds, and the capital solutions arms of large alternative asset managers. Competition among them is intense, and fewer high-quality assets are coming to market. The result is a growing range of bespoke, flexible capital on offer to businesses and their owners.

In this article, we examine company-level (rather than fund-level) preferred equity issued to third party investors. We consider how sponsors and Irish companies looking beyond conventional bank and bond markets can use it and the key reasons for doing so.

What is it?

Company-level preferred equity is typically a class of preference shares issued by an operating company, or, more commonly, by a holding company above it that sits outside the ‘banking group’, to a third-party investor. It ranks as subordinate to all of the group’s debt, including trade creditors, but ahead of ordinary shareholders in dividends and returns of capital.

Typically, company-level preferred equity instruments carry a preferred dividend that is usually rolled up (paid-in-kind) rather than paid in cash. These instruments set a defined exit horizon and include a package of covenants and downside protections, including reserved matters, information rights, tag-and-drag rights, forced-sale rights, and step-in rights.

A key benefit to preference shares is the retention of equity treatment from an accounting perspective.

Preferred equity may also be issued alongside separate warrants, common equity, or LP interests (as appropriate) to enable the investor to maintain some upside-sharing on an exit after the preference shares or notes have been redeemed.

Hybrid capital instruments

Company-level preferred financing can also be delivered via a hybrid capital instrument. This is a loan note, typically issued by a holding company, that carries the economics, governance rights and downside protections of preferred equity, but is legally a debt instrument.

The notes usually bear payment-in-kind (PIK) interest at a rate comparable to that of preference shares, with a long-dated maturity falling after the senior debt, or, in some cases, no hard maturity date (with exit protection achieved through an obligation to commence and pursue a sale process). Alongside the notes, the investor often receives a comprehensive set of preferred equity-style rights.

A key distinction over preference shares is that repayment is a contractual debt obligation. It is not subject to the requirement that the issuer has distributable reserves, which is the main constraint on redemption of preference shares. The investor ranks as a creditor, albeit a subordinated and typically unsecured one, with recourse to creditor remedies once the senior debt is discharged or the intercreditor terms allow.

The trade-off is that loan notes will generally be treated as debt for accounting purposes. Hybrid capital instruments therefore suit sponsors and private companies seeking tax efficiency and are less suited to issuers seeking equity treatment for their instruments. In practice, the choice between preference shares, hybrid capital loan notes, or a combination of the two should be made early, with input from finance, tax, and accounting advisers.

Why use it?

Preferred equity’s main attraction is that it brings in additional capital without adding cash-pay debt at the operating company or the dilution impact of issuing new ordinary equity.

For sponsors acquiring an Irish business, preferred equity can bridge the gap between what senior lenders will provide and the purchase price. Where senior debt is capped at a given leverage multiple, a preferred tranche can fund part of the balance, reducing the sponsor’s own equity cheque. Because the dividend usually accrues rather than being paid in cash, the business retains cash flow for operations and debt service.

For sponsors already holding an Irish portfolio company, preferred equity can be used in a number of ways:

• funding bolt-on acquisitions or capital expenditure without reopening the senior facilities;
• providing a partial liquidity event for the sponsor’s fund or co-investors, as an alternative to a full sale process or running a GP-led continuation fund transaction on the portfolio company;
• deleveraging, curing a covenant issue, or extending runway ahead of a debt maturity where an exit at current valuation may be unattractive.

In these situations, it can serve as a bridge to a better exit environment.

For Irish companies more broadly, preferred equity offers an alternative means to raise growth or acquisition capital while retaining control. Investors in this space are typically more focused on downside protection and generally require fewer day-to-day governance rights than a common equity investor would.

Across asset classes

Preferred equity is not confined to traditional buyouts, and its flexibility makes it relevant across much of the Irish market.

• Corporate and private equity-backed businesses. In the mid-market, which is the core of Irish private equity activity, it can sit alongside senior or unitranche debt in acquisition financings, fund buy-and-build strategies and provide shareholder liquidity in businesses where a full exit is premature.
• Infrastructure, energy and renewables. Developers and platforms in onshore and offshore wind, solar, battery storage and grid infrastructure face significant capital needs during development and construction. Preferred equity at platform or holdco level can provide development capital or fund pipeline growth ahead of project finance. It can also allow a sponsor to recycle capital while retaining control. Data centre and digital infrastructure operators use similar structures internationally.
• Real estate. Preferred equity is a well-established part of the capital stack in commercial real estate. It fills the gap between senior debt and the sponsor’s own equity.

The instrument’s terms and pricing will generally reflect the risk profile of the asset class.

Key commercial terms

Preferred equity terms are highly bespoke, but negotiations tend to focus on a familiar set of issues. Investors are often closed-ended funds with a finite life, so certainty of exit is as important to them as the headline return.

Return. The preferred dividend is commonly cumulative and compounding and rolls up into the liquidation preference rather than being paid in cash. Investors often seek a step-up in the rate if the issuer elects to roll up rather than pay as certain milestone dates pass. A rising coupon also gives the issuer an incentive to redeem what can become an increasingly expensive instrument.

Redemption and exit. Typical redemption or exit triggers include a change of control, a sale or IPO, and a long-stop date. Early redemption by the issuer is often subject to a make-whole or minimum return.

Forced sale rights. If the shares are not redeemed by the agreed date, the investor may be entitled to run, or require the company to run, a sale process. These provisions are invariably negotiated in detail, covering the appointment of advisers, timetable, and whether the investor or its affiliates can participate as bidders.

Step-in rights. Because preferred shareholders cannot accelerate or enforce as a lender would, the most effective remedy is often a right to take control of the board on a breach. This is usually achieved by ‘flooding’ the board or by enhancing voting rights, thereby giving the investor control over any subsequent sale or restructuring. Hybrid capital instruments may also be secured such that the investor may hold, and be entitled to enforce, security over the shares in an intermediate holding company that ranks higher in the capital structure than the senior debt.

Covenants and consent rights. Investors typically require restrictions on additional leverage at both the issuer and subsidiary levels to avoid structural subordination. They also seek limits on the issuance of priming debt or senior equity, dividends and other leakage to ordinary shareholders, affiliate transactions, and changes to the business. Information rights are standard.

Upside sharing. Where participation in equity value is required, upside sharing may be delivered through a conversion right, warrants, or parallel issuance of common equity or limited partner interests in the issuer. Subject to their terms, separate instruments can give investors the flexibility to transfer or retain the upside independently of the preference shares.

Conclusion

Private equity sponsors and corporates are increasingly turning to third-party preferred equity and hybrid capital instruments as flexible tools for financing, liquidity creation and active portfolio management across asset classes. We expect their use in the Irish market to continue to grow. Ireland combines an active mid-market private equity sector with significant capital needs in infrastructure, healthcare, energy transition, real estate and technology. It also has a common-law system that will feel familiar to international investors and sponsors. Together, these make it a natural market for flexible, tailored capital solutions.

For sponsors, these instruments offer a way to fund growth, deliver liquidity and manage exit timing without ceding control or crystallising value at the wrong moment. For Irish businesses, this opens access to a large and expanding pool of international private capital, on terms that can be shaped around the business rather than a lender’s standard requirements, giving both investors and issuers the certainty they need.

Drawing on integrated, cross-practice expertise, William Fry regularly helps sponsors, investors and Irish businesses structure and negotiate preferred equity and hybrid capital that meets their commercial, financing and tax objectives.

The content of this article is provided for information purposes only and does not constitute legal or other advice.