You may have heard mention of preferred shareholders or stocks in investment circles. And you might have wondered: How do I get preferred stocks? Preferred stocks are available to individual investors, but a type of preferred stock may be out of reach to most: Participating preferred stocks.
Here’s a look at participating preferred stock, when one might have the option to own preferred stock, and the benefits of participating preferred stock.
What is Preferred Stock?
Preferred stock shares characteristics of both common stocks and bonds. Preferred stocks allow investors to own shares in a given company and receive a fixed dividend schedule (much like bond interest payments). Because the payout is predictable and expected, there isn’t the same potential for price fluctuations as with common stocks—and thus, there’s less potential for volatility. But, the shares may rise in value over time.
How Preferred Stocks Work
Shares of preferred stock tend to pay a fixed rate of dividend. Preferred stocks have dividend preference; they’re paid to shareholders before dividends are paid to common shareholders.
These dividends may or may not be cumulative. If they are, all unpaid preferred stock dividends must be paid out before common stock shareholders receive a dividend.
For example, suppose a company has not made dividend payments to cumulative preferred stock shareholders for the previous two years. In that case, they must make two years’ worth of back payments and the current year’s dividend payments to preferred shareholders before common stock shareholders are paid any dividend at all.
Because of the dividend’s fixed nature, the investments tend to behave more like a bond. When an investment pays a fixed and predictable rate of interest, they tend to trade in a smaller and more predictable bandwidth. Compare that to stocks, whose future income stream and total return on investment are less predictable, which lends itself to plenty of price disagreement in the short term.
Preferred stockholders do not typically enjoy voting rights at shareholder meetings. But, preferred stock shareholders are paid out before common shareholders in a liquidity event.
Participating Preferred Stocks
Participating preferred stock takes on all of the above features, but they may receive some bonus benefits, such as an additional dividend payment. This additional payment may be triggered when certain conditions are met, often involving the common stock. For example, an additional dividend may be paid out if the dividend paid to common shareholders exceeds a certain level.
Participating preferred shareholders may receive additional benefits upon liquidation, usually over what was initially stated.
For example, they may have the right to receive back the value of the stock’s purchasing price. Or, participating preferred shareholders may have access to some pro-rata cut of the liquidation proceeds that would otherwise go to common stock shareholders.
Nonparticipating preferred stocks do not get additional consideration for dividends or during a liquidation event.
For those with access, participating in preferred stock is an enticing investment. That said, the average individual investor may not be able to invest in participating preferred stock. This type of stock is typically offered as an incentive for private equity investors or venture capital firms to invest in private companies.
The Takeaway
The preferred stock offers some benefits that common stock does not—such as a regular dividend schedule and the potential to increase in value without the threat of volatility. Participating in preferred stock offers investors even more potential benefits, including additional dividends and the opportunity to participate in liquidity events. However, participating preferred stocks are generally an option only for private equity investors or venture capitalists.
Note: ZPEnterprises is not a licensed investor/financial advisor, but we are trying to share awareness of financial topics. Please do further research and work with a licensed financial advisor.
