Definition
Participating Preferred Stock is a type of preferred stock that gives the holder the right to receive dividends equal to the generally specified rate of preferred dividends plus an additional dividend based on some predetermined condition. The additional dividend is usually related to the amount of dividends received by the common stockholders. In case of liquidation, holders of participating preferred stock can also have the right to receive back their original investment plus a pro-rata share of any remaining liquidation proceeds.
Key Takeaways
- Participating Preferred Stock gives shareholders the right to receive dividends before common stockholders. This means, in case of profitability, shareholders of this class of stock receive a planned amount of dividends before others.
- Aside from the initial dividend, holders of Participating Preferred Stock may also receive additional dividends if the company’s earnings reach a certain level. The additional dividends are usually a certain percentage of the company’s earnings, and are shared with common shareholders.
- The third important aspect of Participating Preferred Stock is their preferential treatment during liquidation. If a company is dissolved, participating preferred shareholders are paid back their initial investment before common shareholders, and may also receive a share of any remaining assets or profits.
Importance
Participating Preferred Stock is an essential term in finance as it refers to a type of preferred stock that gives the holder the right to receive dividends equal to the normally specified rate that preferred dividends receive as well as an additional dividend based on some predetermined condition.
The additional dividend usually relates to the percentage of profits realized by the company.
This feature of participating preferred stock provides its holders with a greater potential for return on investment.
It also creates a more appealing financial instrument for investors, particularly for venture capitalists, as it provides them with a superior claim on the company’s assets and earnings.
Therefore, understanding Participating Preferred Stock is crucial in corporate finance and capital raising activities.
Explanation
Participating Preferred Stock serves the purpose of offering investors a greater promise of return compared to common stockholders. This type of stock guarantees dividends and a previously decided percentage of the company’s profit above the expected return, providing a higher level of investment stability.
This is particularly beneficial in the case of the company’s wind-up, where such stockholders have a preferential right to the company’s assets over common stockholders. Investors with Participating Preferred Stock have the option to earn more than their stated dividend due to the profitability of the business.
In practical terms, Participating Preferred Stock is often used as a tool for attracting investment to a company, especially for startups seeking venture capitalists. Due to its structure, this form of investment is often more appealing to potential investors who are looking to reduce the risk associated with traditional equity investments.
It’s used as a mechanism to protect investors in the event of a sale of the company, ensuring they receive their original investment back, along with a proportion of any remaining profits. This offers an edge to investors, particularly in situations where the company performs exceedingly well, thereby creating a win-win situation for both the company seeking funds and the investors.
Examples of Participating Preferred Stock
Sure, let’s discuss three real-world examples of participating preferred stock.
Dropbox, a renowned technology company, issued participating preferred stock to its early-stage investors. This occurred before the company went public. The shareholders of the participating preferred stock were allowed to get the dividends and also participate in the leftover profits proportionate to their ownership after the common stock shareholders have been paid.
Jawbone – In 2011, Jawbone which is a consumer electronic company headquartered in San Francisco, raised around $70 million in the form of participating preferred stock. These investors enjoyed a guaranteed dividend as well as potential further upside from the common stock participation.
GoPro – Another example is GoPro, a famous action cameras company who issued participating preferred stock as it prepared for its initial public offering. The preferred shares were particularly appealing because if the firm met certain performance targets, the preferred stockholders would receive a dividend. They would also participate in the success of the firm through the increase in the share price of their common stock.These serve as examples of how companies may use participating preferred stock as a tool to attract additional funding from investors who want to participate further in the company’s potential future success, beyond regular dividend payments.
FAQs on Participating Preferred Stock
What is Participating Preferred Stock?
A Participating Preferred Stock is a type of preferred stock that gives the holder the right to receive dividends equal to the generally specified rate that preferred dividends receive as well as an additional dividend based on some predetermined condition. The additional dividend often comes in the form of getting a portion of the profits of the company.
What is the difference between Participating Preferred Stock and Common Stock?
Participating Preferred Stockholders have a higher claim on the assets and earnings than common stockholders. They receive dividends before the common stockholders and they also share in the company profits. Additionally, in the event of liquidation, Participating Preferred Stockholders receive their investment back before common stockholders.
What are the advantages and disadvantages of Participating Preferred Stock?
The advantage for the stockholder is the earning potential as they receive dividends and a portion of the company profits. The disadvantage is that these types of stocks restrict companies ability to distribute profits as the companies often must set aside a specific amount of profit for these stockholders.
Is Participating Preferred Stock a good investment?
Whether Participating Preferred Stock is a good investment or not depends on various factors such as the investor’s risk tolerance, the company’s financial performance and market conditions. Given their preferential treatment with regards to dividend payments and liquidation, they can be attractive to certain investors. It’s recommended to thoroughly research any investments before making decisions.
Related Entrepreneurship Terms
- Dividends
- Liquidation Preference
- Equity Financing
- Convertible Securities
- Cap Table
Sources for More Information
- Investopedia – A comprehensive website dedicated to investment and finance education.
- Corporate Finance Institute (CFI) – This institute provides online courses and certification programs related to corporate finance.
- Divestopedia – An educational resource for business owners and professionals to learn more about mergers, acquisitions and other business strategies.
- The Balance – This website offers expertly crafted content to guide you through your personal finance questions.
