Is Preferred Stock Used in Mergers and Acquisitions: Consideration, Buyouts, and Waterfalls (2026)

Yes, is preferred stock used in mergers and acquisitions is one of the most common structuring questions advisors get, and the short answer is that preferred stock shows up in roughly 38% of middle-market deals either as part of the consideration paid to sellers or as the sponsor equity layer financing the buyer (SRS Acquiom 2025 Deal Terms Study). It carries dividend rights, a liquidation preference that sits ahead of common, and conversion features that decide who actually walks away with the upside. Owners who do not understand how their preferred stack works at closing routinely lose seven figures to misread waterfalls.

What This Actually Means

Preferred stock is a class of equity that sits between debt and common stock in the capital structure. It pays a defined dividend (cash or accrued), has a liquidation preference that gets paid before common in any sale or wind-down, and usually carries the right to convert into common stock if conversion produces a better outcome. Delaware General Corporation Law Section 151 is the statute that authorizes a corporation’s board to create one or more classes of preferred with whatever rights, preferences, and limitations the certificate of designation specifies, which is why preferred terms vary wildly deal to deal.

In M&A, preferred stock appears in two distinct ways. First, as consideration: the buyer pays the seller partly in preferred stock instead of (or alongside) cash and common. Second, as financing: a private equity sponsor capitalizes the acquisition vehicle with a preferred equity layer that sits above common but below the senior debt. The same instrument, very different roles. The NVCA Model Legal Documents (2025 version) codify the market-standard preferred terms for venture-style deals, and Cooley GO’s 2025 deal structures guide tracks how those terms migrate into M&A consideration packages.

The reason preferred matters in M&A is not academic. Liquidation preferences, participation rights, dividend accruals, and conversion math all run through the cap-table waterfall at the next exit. When a $200M sale gets carved up, preferred holders frequently take the first $80M to $120M off the top before common sees a dollar. If a founder rolled into preferred at the first deal and accepted standard terms without modeling the waterfall, the second exit can return materially less than expected.

The Seven Things You Need to Understand About Preferred Stock in M&A

1. Preferred Stock as Acquisition Consideration

When a strategic buyer or PE sponsor pays for a target partly in preferred, the deal sheet usually looks like a mix of cash, buyer common stock, and a preferred tranche. The preferred tranche carries a face value, a dividend rate (typically 6% to 10% in 2025 middle-market deals per Cooley GO), and a liquidation preference equal to face value. SRS Acquiom’s 2025 Deal Terms Study reports that mixed-consideration deals using preferred made up about 24% of private-target M&A in 2024, up from 18% in 2022, driven by sellers who wanted continued upside without holding plain common in a thinly traded buyer.

The current state for sellers is a binary choice: take all cash and walk, or take partial preferred and stay exposed. The target state, when preferred is structured well, is downside protection (the liquidation preference) plus upside participation (the conversion feature). The impact on outcome is material: a seller who took 30% of consideration in well-structured convertible preferred in a 2020 deal that subsequently doubled in value captured roughly 1.4x what an all-cash seller earned, after tax, per the Carta 2025 State of Private Markets analysis of rollover outcomes.

2. Preferred Stock in Private Equity Buyouts

In a sponsor-led buyout, the capital stack is built from the bottom up: senior debt, subordinated debt or mezzanine, preferred equity, and common equity. The sponsor’s equity check is frequently split, with most of it as preferred (often called “sponsor preferred” or “Series A preferred” in the NewCo) and a thin slice as common. Why? The preferred earns a PIK dividend (8% to 12% is common in 2025, per Capstone Partners middle-market data), which compounds for the sponsor and creates a hurdle the common has to clear before management’s equity is worth anything.

Management rollover usually goes into common, or occasionally into a separate junior preferred. The current state is that selling owners are offered a mix of cash plus rollover into NewCo common, and they often do not realize how thick the preferred layer above them is. The target state is rollover into the same preferred class as the sponsor, on the same terms, pro rata. The impact is enormous: rollover common behind a 10% PIK preferred has to outrun a doubling cap-table preference roughly every seven years just to stay flat. Owners who roll into common without understanding the PIK toggle frequently discover their stake is worth zero at a flat exit.

3. Liquidation Preferences: 1x Non-Participating Is the Standard

The liquidation preference defines what preferred holders get before common at a sale. The three flavors are non-participating (preferred takes the larger of liquidation preference or as-converted common, not both), participating (preferred takes liquidation preference AND its pro-rata share of remaining proceeds), and capped participating (participating up to a multiple cap, then non-participating beyond). Per the NVCA’s 2025 model term sheet commentary and Cooley GO’s quarterly deal terms report, 1x non-participating is the standard for venture preferred and increasingly for M&A consideration preferred, used in roughly 84% of 2024 deals tracked by Cooley.

Participating preferred (sometimes called “double-dip” preferred) is uncommon in 2025, appearing in under 9% of new financings per Carta, but it lingers in older cap tables and shows up in distressed deals where the buyer has the upper hand. Capped participation is rare, used in roughly 4% of deals. The current state owners need to audit: if your existing cap table has participating preferred from an older round, the next M&A exit will route disproportionately more to those holders. Target state: convert participating preferred to non-participating (or buy it out) before launching a sale process.

4. The Preferred Waterfall: Who Gets What at Closing

The waterfall is the algorithm that splits sale proceeds across the cap table. Senior debt is paid first, then any junior debt, then preferred (in seniority order: senior preferred before junior preferred), then common pro rata. Inside the preferred layer, each series has its own liquidation preference plus accrued dividends. The math gets messy when there are multiple series, anti-dilution adjustments, and conversion elections in play.

A simple illustration: a company sells for $100M. Debt is $20M. Preferred consists of $40M Series B (senior) and $25M Series A (junior), both 1x non-participating, with no accrued dividends. Common is 5M shares; preferred converts to 4M Series B shares and 3M Series A shares. At $100M minus $20M debt equals $80M for equity. Series B compares: $40M preference vs ($80M times 4M / 12M total shares) equals $26.7M as-converted. Series B takes the $40M preference (larger). Now $40M remains. Series A compares: $25M preference vs ($40M times 3M / 8M remaining shares) equals $15M as-converted. Series A takes the $25M preference. Now $15M remains for 5M common shares, or $3 per share. The common holders, who may have founded the company, take 15% of the proceeds.

5. Preferred Plus Rollover Equity and Tax Treatment

When a seller rolls a portion of their consideration into NewCo preferred, the tax treatment depends on whether the transaction qualifies as a tax-free reorganization under Internal Revenue Code Section 368. If the structure qualifies (typically a Section 368(a)(1)(A) statutory merger, (B) stock-for-stock, or (C) substantially-all-assets-for-stock), the seller defers gain on the equity portion. Cash and boot are taxable now; equity received is tax-deferred until the next sale of that equity.

The catch: Section 368 requires “continuity of interest,” meaning the seller must receive a meaningful equity stake (typically 40%+ of total consideration as equity per the safe harbor in Rev. Proc. 77-37) and the equity must be in the acquiring corporation or its parent. Preferred stock counts as equity for Section 368 purposes, but “nonqualified preferred stock” under IRC Section 351(g) (preferred with mandatory redemption, fixed dividend, no participation) is treated as boot and triggers immediate tax. Owners who think they are rolling tax-free into preferred sometimes find they actually received nonqualified preferred and owe tax on the whole rollover. The fix: structure the preferred with conversion rights and participation features that disqualify it from Section 351(g) treatment.

6. Drag-Along, Tag-Along, and Anti-Dilution Provisions

Preferred stock terms include three rights that decide who controls the next exit. Drag-along: if holders of a specified percentage of preferred (often 60% or majority of each series) approve a sale, all other holders (including common) must vote yes. Tag-along: if major holders sell their shares to a third party, minority holders can “tag” their shares into the same sale at the same price. Anti-dilution: if the company issues new preferred at a lower price, existing preferred adjusts its conversion ratio to protect against dilution (broad-based weighted-average is the 2025 standard per NVCA, appearing in 91% of deals; full-ratchet anti-dilution is rare, under 5%).

The current state for owners selling now: the drag-along provisions in your existing cap table determine whether you can force minority holders to come along. If a sponsor needs 100% of equity and your drag is broken, the deal falls apart or you negotiate piecemeal. Target state: clean drag-along covering 100% of equity, exercisable by board approval plus majority of preferred. Impact: clean drag closes deals two to four months faster on average per Capstone Partners’ 2025 middle-market data.

7. Preferred Stock in Distressed Deals

When a company sells in distress (below total preference stack), the waterfall punishes common first, then junior preferred, then senior preferred. If proceeds do not cover the senior preference, junior preferred and common get nothing. ASC 480 (FASB classification of preferred stock) treats mandatorily redeemable preferred as a liability rather than equity, which matters for distressed analysis because liability-classified preferred sits closer to debt in liquidation priority and on the balance sheet.

ASC 815 (embedded derivatives) requires bifurcation of certain conversion features and put rights from the host preferred instrument, which can create surprise mark-to-market accounting hits at closing. Distressed deals frequently restructure preferred via consent solicitations, exchange offers, or pre-packaged bankruptcy. The current state for owners holding preferred in a distressed target: the preference is only as good as the proceeds. Target state: negotiate a “minimum payment” carve-out for common in any below-preference sale (5% to 15% of proceeds is the range Cooley GO observed in 2024 distressed transactions). Impact: even a 5% common carve-out on a $50M distressed sale returns $2.5M to common holders who would otherwise zero.

Worked Example: $50M PE Buyout with Mixed Preferred Consideration

Picture Meridian Industrial Services, a fictional but realistic Midwest electrical contractor doing $42M revenue and $6.2M EBITDA. A middle-market PE sponsor offers $50M total enterprise value at 8.0x EBITDA, with the following structure.

Sources of funds total $50M of buyer-side capital (senior + mezz + sponsor equity) plus $20M of seller-side rollover (seller preferred + management common, netted against the $50M purchase price). Uses: $30M cash to seller, $15M to refinance existing debt, $5M transaction fees and reserves.

Fast forward five years. Meridian sells to a larger strategic for $120M. The waterfall runs as follows. First, repay senior debt now amortized to $14M and mezz now $8M plus accrued: total debt $22M. Equity proceeds: $98M. Preferred stack: sponsor $15M plus 5 years of 10% PIK compounded equals $24.2M; seller rollover preferred $15M plus 10% PIK equals $24.2M; total preferred preference equals $48.4M. Each preferred holder compares preference to as-converted common: at $98M equity value with say 10M as-converted shares total ($2M sponsor common at 2M shares, $5M management common at 5M shares, plus preferred-as-converted of 3M shares), the as-converted value per share is $9.80. Sponsor preferred as-converted at 1.5M shares equals $14.7M (less than $24.2M preference, so take preference). Seller preferred same math, take $24.2M preference. Remaining for common: $98M minus $48.4M equals $49.6M. Sponsor common 2M shares of 7M total equals 28.6% or $14.2M. Management common 5M shares equals 71.4% or $35.4M.

The seller’s total proceeds: $30M cash at closing (taxed) plus $24.2M from preferred at exit (taxed). Management: $35.4M from common at exit, less original $5M cost basis. The sponsor’s total: $15M preferred plus $2M common in, $24.2M preferred plus $14.2M common out, return of 2.26x on $17M invested. The key insight: the seller got downside protection (preferred preference) and earned the same 10% PIK as the sponsor, while management took the equity risk in exchange for outsized upside. If Meridian had sold for $60M instead of $120M, the seller’s preferred would still pay $24.2M while management common would have collapsed to roughly $4M.

Common Mistakes

Treating Preferred as “Like Cash But With a Dividend”

Preferred stock is not cash, and it is not debt. It pays only if the next exit clears the preference, and even then only after senior preferred ahead of it. Owners who model rollover preferred at face value are overstating the value of their consideration. Discount the preferred to reflect time value, default risk, and the probability of a successful exit (typical discount: 20% to 40% of face value for a five-year hold per Capstone Partners).

Accepting Nonqualified Preferred Stock Without Knowing It

If the preferred has mandatory redemption, a fixed dividend, no conversion, and no participation in residual proceeds, it is nonqualified preferred under IRC Section 351(g) and treated as taxable boot in a Section 368 reorganization. The rollover is no longer tax-deferred. The fix is structural: add a meaningful conversion feature or participation right that disqualifies the instrument from Section 351(g) treatment. This requires tax counsel review before signing the merger agreement.

Ignoring the PIK Compounding Effect

A 10% PIK dividend on $15M preferred is $24.2M after five years. The preference grows whether the company performs or not. Owners who roll into common while sponsors hold PIK preferred are watching their hurdle race away from them. Either match terms (roll into the same preferred class) or negotiate a higher rollover-common percentage to offset the PIK drag.

Skipping the Cap Table Waterfall Model

Every M&A deal with preferred stock should be modeled at three exit scenarios: bear case (50% of purchase price), base case (1.5x purchase price), and bull case (3x purchase price). Run the waterfall at each scenario. Owners who skip this step regularly discover at the second exit that their preferred was worth far less than the face value suggested.

Misunderstanding Drag-Along Triggers

If your existing preferred drag-along requires consent of multiple series voting separately, a minority preferred holder can block a sale. Fix this before launching the process. The cleanest drag-along is “majority of all preferred voting as a single class plus board approval,” and it removes the holdout risk that derails 11% of middle-market signed LOIs per SRS Acquiom’s 2025 study.

Forgetting About Accrued Dividends at Closing

If your preferred accrues cumulative dividends, those accrued amounts get added to the preference at closing. A $20M preferred series with 8% cumulative dividends unpaid for four years adds $7.4M of compounded preference. Make sure the LOI and merger agreement specify whether closing settles, forgives, or carries forward accrued dividends. Buyer and seller frequently have different assumptions, and the gap is found at the closing waterfall.

Timeline: How Preferred Stock Plays Out in an M&A Process

Phase 1: Pre-marketing (weeks 1 to 4). Audit the existing cap table. Identify every series of preferred, its preference amount, accrued dividends, conversion ratio, anti-dilution adjustments, and any change-of-control provisions. Build the as-is waterfall at three exit scenarios. Clean up any participating preferred or broken drag-alongs before going to market.

Phase 2: Marketing (weeks 4 to 12). Present the cap table cleanly to bidders. Show preference stack, fully diluted share count, and pro forma common-equivalent ownership. Buyers price off the equity-purchase-price, not the enterprise value, so a clean waterfall accelerates bidding.

Phase 3: LOI negotiation (weeks 12 to 16). The LOI specifies consideration mix (cash, common, preferred). Negotiate the preferred terms here: dividend rate, liquidation preference, conversion ratio, drag-along, anti-dilution, redemption rights. Once these are in the LOI, they are very hard to renegotiate.

Phase 4: Definitive agreement (weeks 16 to 24). The merger agreement and certificate of designation finalize the preferred terms. Tax counsel confirms Section 368 qualification. Accounting reviews ASC 480 (liability vs equity classification) and ASC 815 (embedded derivative bifurcation). Auditor sign-off on day-one accounting for the preferred.

Phase 5: Closing and post-closing (weeks 24 to 28). The waterfall runs. Cash flows to sellers. Preferred is issued (typically via DTC for public buyers, via paper certificates or DTC eligible electronic for private NewCos). Sellers receive their preferred and start the holding period for the next exit.

Frequently Asked Questions

Is preferred stock common in private company M&A?

Yes. SRS Acquiom’s 2025 Deal Terms Study reports preferred stock features in roughly 38% of private-target M&A transactions, either as consideration paid to sellers (24% of deals) or as sponsor financing in the buyer’s capital structure (14% of deals). It is most common in PE buyouts and in deals where the buyer is also private (no liquid stock to pay with).

What is the difference between participating and non-participating preferred?

Non-participating preferred takes the larger of its liquidation preference or its as-converted common share at exit, but not both. Participating preferred takes the liquidation preference AND its pro-rata share of remaining proceeds as if it had converted, effectively double-dipping. The 2025 market standard is 1x non-participating, used in roughly 84% of deals per Cooley GO. Participating preferred favors investors and dilutes founder/common returns.

Does preferred stock qualify for tax-free treatment in an M&A rollover?

Sometimes. If the transaction qualifies as a Section 368 reorganization (typically a statutory merger or stock-for-stock exchange) and the preferred is not “nonqualified preferred stock” under IRC Section 351(g), the rollover is tax-deferred until the seller sells the preferred. Nonqualified preferred (mandatory redemption, fixed dividend, no conversion, no participation) is treated as taxable boot. Always confirm the Section 351(g) analysis with tax counsel before signing.

How is preferred stock classified on the balance sheet?

ASC 480 governs classification. Mandatorily redeemable preferred is classified as a liability. Conditionally redeemable preferred (redeemable at the holder’s option or upon a contingent event outside the issuer’s control) is classified as mezzanine equity (between liabilities and equity). All other preferred is classified as permanent equity. The classification affects EPS calculations, debt covenants, and how acquirers price the target.

What dividend rate is typical on M&A preferred stock in 2026?

For sponsor preferred in PE buyouts, 8% to 12% PIK is the 2025 range per Capstone Partners middle-market data. For rollover preferred paid to sellers, 6% to 10% is typical per Cooley GO. The rate is driven by base rates (SOFR), credit quality of the target, and the seniority of the preferred in the capital stack. Higher PIK rates compound faster and create a steeper hurdle for common holders.

Can preferred stock holders force a sale of the company?

Sometimes, via redemption rights or forced sale rights baked into the certificate of designation. Some preferred has a “put right” exercisable after a fixed date (often 5 to 7 years post-issuance) that forces the company to redeem at face value plus accrued dividends, or to facilitate a sale to provide liquidity. Sponsor preferred frequently includes a forced-sale right exercisable by majority preferred consent. Common-only owners can be dragged along by a preferred-triggered sale.

How CT Acquisitions Approaches This

CT Acquisitions is buyer-paid. Owners thinking about a sale that involves preferred stock as consideration (or anywhere in their existing cap table) talk to us without paying retainer or success fees. We model the cap-table waterfall at three exit scenarios before any LOI gets signed, so owners see what the preferred is actually worth versus the headline number on the term sheet.

We sit on the seller’s side of the table reading the buyer’s preferred terms the way an institutional investor would: dividend rate, liquidation preference, conversion math, drag-along, anti-dilution, redemption. Owners who try to read the certificate of designation alone routinely miss the Section 351(g) trap, the participation creep, or the PIK compounding. We catch those before they become permanent.

What to Do Next

If you are evaluating an LOI that includes preferred stock as part of the consideration, or if your existing cap table includes preferred from a prior round and you are thinking about selling, talk to us before you sign anything. The terms in that preferred decide what your second exit pays you, and they are very hard to renegotiate after closing.

Related reading: Who gets the money in a business sale, how investment bankers value a business, and sell your business with CT Acquisitions.