This is the second in a three-part series on preferred equity in private capital markets. This Legal Update examines how preferred equity compares to traditional financing alternatives and the principal legal risks that should inform structuring and negotiation. For background on preferred equity features and use cases, see the first installment in this series.

Executive Summary

Preferred equity occupies a unique position in the capital structure, sitting above common equity but below all debt. But unlike senior or mezzanine financing, preferred equity does not carry creditor status, which means it generally lacks the enforcement mechanisms, collateral, and priority protections that debt investors rely on in distress scenarios.

This Legal Update examines how preferred equity compares to senior secured debt, mezzanine debt, and common equity and identifies key legal and bankruptcy risks.

Preferred Equity Compared to Capital Structure Alternatives

Preferred Equity vs. Senior Debt

Senior debt sits at the top of the capital structure, benefiting from collateral, contractual covenants, and creditor enforcement rights, including acceleration and foreclosure. Preferred equity, by contrast, is structurally subordinated to debt and does not carry creditor enforcement rights.

Even where preferred equity includes fixed return obligations or mandatory redemption provisions, failure to make distributions does not typically create the same remedies available to creditors pursuant to applicable statutory and bankruptcy law—preferred equity rights are only enforceable as contractual equity rights.
Other key differences include the following:

• Priority in Bankruptcy: Senior debt sits at the top of the capital structure, while preferred equity ranks junior to all debt. Preferred equity holders remain equity claimants under insolvency law and therefore remain exposed to restructuring outcomes that may not preserve contractual distribution priorities.
• Security: Secured debt benefits from a pledge of collateral, whereas preferred equity generally does not.
• Enforcement: Senior lenders have acceleration, foreclosure, and creditor remedies; preferred equity...