Topic 28
Equity Investor Risk
Topic 28 adds to the concepts of the equity risk premium demanded in M&A deals by focusing on the priorities generally governing access to free cash flow. The equity holder usually is the last in line—yet another reason to demand the equity risk premium.
OVERVIEW
- In liquidations (and in going concerns), equity investors usually are the last in line to realize the economic benefit of available free cash flows. The general order is:
- Taxes due get paid first.
- Then secured senior creditors or debt holders.
- Then subordinated debt holders.
- Then preferred stockholders.
- Then general creditors and unsecured creditors.
- Then common equity holders.
- Equity holders have, therefore, demanded an equity risk premium in recognition of being last in line (both when things are going well or when things go wrong and last for a long time and cannot be well controlled).
- Equity owners’ risk in an acquired equity stake can be mitigated if management can exercise control over those factors affecting the target's business (so-called unsystematic risks, see Topic 31).
