The current “higher for longer” interest rate environment has had a range of consequences for fund finance participants, including the increased focus by private equity sponsors and investors alike on stable and predictable returns and a more stagnant equity market for both private and public companies.

While this shift is likely driven by a combination of factors, it is apparent that the emergence of increased fixed-income yields has coincided with the reduction of traditional equity investing. One trend that has increased with the rise in rates is the use of preferred equity by private equity sponsors. Investors in search of stable returns have grown more comfortable with instruments that offer fixed-income characteristics, as opposed to traditional equity, and preferred equity offers investors the ability to retain some of the rights that they would otherwise have when holding traditional common equity, while holding an instrument that pays a fixed-income yield.

Toward the end of a traditional closed-end fund’s life cycle, investors are often eager to find liquidity and the options for a sponsor for late-stage financing are generally limited. Net Asset Value (NAV) financing has traditionally been the most common solution for private equity funds seeking to finance their portfolio holdings, but NAV financing is not always available. Likewise, funds have raised capital through secondary offerings and continuation funds, but these options typically require the existing investors to exit their stakes in whole or in part.

Given the increased rates and slower equity markets, preferred equity has emerged as a viable alternative source of capital. These issuances address liquidity needs for both private equity fund limited partners (LPs) and fund sponsors. Importantly, preferred equity issuances are also able to generate liquidity while minimizing disruption to existing capital structures and fund economics, without depending on third-party lending from a bank or third-party...