Reading 34: Alternative Investm....olio Management－LOS j investment, capital, venture, direct

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CFA Institute Area 8-11, 13: Asset Valuation
Session 11: Alternative Investments for Portfolio Management
Reading 34: Alternative Investments Portfolio Management
LOS j: Discuss the use of convertible preferred stock in direct venture capital investment.

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Frank Campbell, CFA, has a client who wants to make a venture capital investment. Campbell is considering recommending convertible preferred. This would least likely be appropriate if the client wishes to:

A) have a priority of claims over common stockholders.

B) have a priority of claims over subsequent investors in the company.

C) benefit in the case of a buyout of the company.

D) receive dividends.

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Answer and Explanation

Typically, investors in subsequent rounds after preferred stock issuance will have senior claims to preferred stock. All the other choices are reasons to invest using convertible preferred stock.

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Compared to common stockholders, investors who use convertible preferred stock to make venture capital investments will receive the promised dividend:

A) before common stockholders receive a dividend or a disbursement through liquidation.

B) before common stockholders receive a dividend but not if there is a liquidation.

C) after common stockholders receive a dividend or a disbursement through liquidation.

D) only if common stockholders receive a dividend or a disbursement through liquidation.

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Answer and Explanation

Preferred stockholders must be paid a specified amount, say twice the initial investment, before common stockholders can receive cash in the form of dividends or distributions through liquidation.

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The convertibilty feature in convertible preferred stock is important because it means that preferred stockholders:

A) can block a possible buyout.

B) will receive all the dividends promised.

C) can convert their claims to equal those of later investors in the company.

D) can benefit from a buyout favorable to common stockholders.

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Answer and Explanation

Any buyout of the company that is favorable to shareholders will lead to the conversion of the preferred stock.