PROFIT-PARTICIPATION RIGHTS
Profit participation rights represent a form of mezzanine financing in which the investor (holder of the profit participation rights) provides capital to the issuer (the company) and, in return, receives profit participation certificates that grant financial rights (e.g. a share in profits, or option rights). These certificates entitle the holder to repayment of the nominal value plus a share in net profit, either as interest or profit entitlement. Depending on the specific terms of the contract, profit participation rights can resemble either interest-bearing loans or shares, with hybrid forms also being possible. Features such as potential participation in ongoing profits and losses, subordination agreements, and longer durations might bring profit participation certificates close to equity capital. Unlike shareholders who hold equity in a company, certificate holders generally do not possess voting rights or direct ownership of the company. However, they have a higher priority in receiving profits compared to common shareholders.
Profit participation rights are an easy-to-implement and measure instrument with a well-known structure to many in the investment world. Still, there are some things to consider:
- From a steward-ownership perspective, profit participation certificates are a nice tool, as entrepreneurs can tailor the terms of the certificates extensively. For example, they can define conditions for profit distributions (periodic or lump-sum), the term of the investment (fixed or minimum duration), and the arrangement of a loss participation or subordination. They can also be structured to include a fixed, regular payment, such as a base interest rate combined with profit participation.
- At the same time, control and co-determination rights can be just as flexibly determined.
- It can serve as a less invasive, short-term solution for companies, acting as a bridging instrument; or, if designed properly, it can serve as a medium- to long-term solution that can be used across several financing rounds (e.g. VYLD).
- One attractive feature of profit-participation certificates is the possibility of issuing smaller certificates to a larger group of investors; though this may lead to increased administrative effort for ongoing management. Note that some jurisdictions may limit the total amount or number of certificates issued.
- Profit-sharing certificates also are an easy investment instrument to involve employees in employee-owned companies or members of cooperatives.
- Similar to silent partnerships, the classification of profit participation certificates depends on their specific design. While they can be accounted for as equity depending on their structure (e.g., in the case of VYLD), financial institutions still may not always recognize them as such.
Profit-sharing certificates can be issued by both public and private companies, and they are often used as a means of raising capital or attracting investors who are seeking a combination of equity-like returns and fixed-income characteristics. Profit participation rights can be particularly useful for companies preparing for significant growth investments, as they help to raise sufficient equity and with an appropriate lock-up period, companies can secure a sufficient growth timeframe. For startups, especially those seeking funding from angel investors, profit participation certificates can serve as a flexible alternative or complement to traditional equity shares. Additionally, companies can market these certificates to a broader audience – including stakeholders – through standardized financing platforms, such as crowdfunding, using the support of specialized agencies.
- Total obligation
- Profit Participation Rate (% of the company’s profits allocated to the investor)
- Loss Participation (some agreements allow investors to share in losses, while others limit downside risk to the invested amount)
- Term & Maturity (can be structured as fixed-term or indefinite, with predefined exit or termination options).
- Payout Structure
- Ranking & Seniority
- Control & Governance Rights
- Early Repayment or Buyout Options (some agreements allow the company to buy out the investor at a predefined multiple or valuation)
- Convertible Options (if applicable)
