Meaning
Systematic investigation of the capital structure focuses on the specific rights and liquidation hierarchies of senior share classes. Investors perform preferred equity diligence to understand the exact order in which proceeds are distributed during a sale or wind down. This review examines the articles of incorporation and any shareholder agreements.
Economic Priority
Liquidation preferences dictate the multiple of the original investment that must be paid to preferred holders before common shareholders receive anything. A participating preference allows the investor to receive their initial capital and then share in the remaining proceeds. Non participating preference forces a choice between the preference amount or the pro rata share.
Governance Control
Protective provisions grant preferred shareholders the power to veto specific corporate actions such as a merger or the issuance of new debt. These rights exist independently of board representation. A founder must document every instance where such a veto was exercised or waived to maintain an accurate history of board decisions.
Documentary Accuracy
Verification requires a side by side comparison of the cap table against the physical stock purchase agreements. Discrepancies between the electronic record and the signed documents can delay a closing by weeks. The administrative cost of correcting these records involves legal fees and the signatures of every affected party.
