Some leveraged buyouts leave spirit behind that can haunt a company for years.

Such is the case with privately owned Telos Corp., a small defense technology contractor.

Telos went through a leveraged buyout in 1989, when New York financier Fred Knoll financed a takeover of the Ashburn company. He bought it for $133 million, and $28 million of that was financed by selling publicly traded preferred stock. Sixteen years later, the preferred stock lurks on Telos's balance sheet like a specter. Because of it Telos may be forced to go through some kind of recapitalization, sale or public stock offering in the next year.

The total value of the preferred stock, including its face value and the dividends that have accrued for years, is close to $70 million. Telos is required to begin paying it all back in five equal, annual installments beginning in October. But Telos has said in filings with the Securities and Exchange Commission that it doesn't have the cash to make those payments.

Enter the hedge funds. Four hedge funds -- investment partnerships for institutions and wealthy individuals -- have bought up more than half of that preferred stock. They don't want to delay the redemption. They want their money. That leaves Telos with few options, and the hedge funds are pressing for Telos to sell itself or do an IPO to raise the cash.

Warren Jones, a Telos spokesman, declined to comment for this story. Representatives of the three hedge funds that have written a letter to the Telos board pushing for a sale or IPO also declined to comment.

However, a source familiar with the thinking of Telos management agreed to speak on condition of anonymity because the issue could wind up in court, and Telos's struggle with its preferred stock is laid out in years of SEC filings.

Telos, which in 1989 was known as C3 Inc., is a computer network and communications security firm that does business with the military and intelligence agencies. Judging from its contracting successes and sales growth, business has been good. Last September, it was one of eight companies that won a shot to compete for up to $9 billion in contracts to create the next-generation communications network for the Air Force.

Telos revenue has grown in each of the past three years, reaching $116.7 million last year. Before interest on its nearly $100 million debt, it was operationally profitable last year, but $8.8 million in interest led to a $3 million loss for 2004.

So while Telos's business is good, its balance sheet isn't.

Including its preferred stock, which for accounting purposes is classified as debt, the company's liabilities outstrip its assets by $84 million.

As long as it was able to defer making $3.8 million a year in dividend payments on its publicly traded preferred stock -- it hasn't paid a dividend since 1995 -- things kept chugging along. But now the bill is coming due. A total of $38.7 million in dividend payments on the preferred stock has stacked up. The company has no cash cushion to speak of, with just $63,000 in cash on hand on March 31.

Even if it had the cash, buying out the public preferred stockholders would be tricky. Other creditors have higher claims on the company's assets. And the laws of Maryland, where Telos is incorporated, bar making dividend payments on preferred stock when the company has negative shareholder equity.

Then there are the options of selling the company or going public simply to raise enough money to cash out the preferred stockholders.

In such a deal, the big loser would be John Porter, a London investor who inherited most of his money from his family's grocery chain in England. He bought the company from Knoll in 1993 and owns 80 percent of the common stock -- most of the rest is held by Telos's management and employees -- and also owns senior preferred stock that is separate from the shares now in dispute. Porter is also paid $260,000 a year in fees by Telos for advice on "marketing, product development, strategic planning and finance," even though as a foreign national he is barred from exercising any control over the company. In a sale of the company, most of the cash would go to the banks and the public preferred stockholders, not to Porter.

Management also has a lot riding on Telos. Chief executive John B. Wood, 41, has been associated with the company for more than 13 years. Wood has options on more than 3 million shares of common stock. He was paid more than $1 million in salary and bonus last year.

The source close to Telos management said the company does not believe now is the time for a sale or IPO. He added that the company is in the middle of a multi-year plan that could make it far more valuable, enabling it to restructure its balance sheet and make good on all its obligations. It just needs time, this person said, and "everyone will be paid off in the course of a few years."

But the hedge funds have other ideas. In their letter to the Telos board, they put the company's value at $80 million to $100 million, which could be realized in an IPO or sale. It's easy to see why they want to push for a cash transaction: a big, quick profit. The total market value of the outstanding preferred stock, which last traded at $7.75 a share, up from $3.45 a year ago, is about $24.7 million, far less than the redemption value of $70 million that includes the deferred dividends. The hedge funds, in an apparent display of generosity, added in their letter that they would be willing to consider reducing the dividends they are owed if it would help get the job done.

Telos has formed a committee of three independent directors to evaluate options for dealing with the preferred stock problem and has hired a lawyer and an investment firm, neither of which it has named, to come up with a solution. Or maybe an exorcism.

Terence O'Hara's e-mail is