What is Preferred Stock?
Preferred stock is stock in a corporation with preferential rights. All corporations issue common stock as a baseline class of ownership. The company may then issue other classes of stock with rights that differ from those of the common stockholder. This ownership class has a superior claim on the income and assets of the company as compared to common stock.
How Does Preferred Stock Work?
A preferred stockholder generally has various rights that a common stockholder does not have. Also, the preferred stockholder may not have some of the rights of the common stockholder. Below are some of the common preferences of a preferred shareholder:
Dividends – The preferred shareholder generally gets paid dividends before a common shareholder. Further, she may have guaranteed dividend rights. These dividends may be cumulative (build up each year until a dividend is paid).
Liquidation Rights – The preferred shareholder may be repaid her investment (or a multiple of her investment) before common shareholders receive any money from the sale of the business.
Conversion Rights – The preferred shareholder may be able to convert her shares to common shares if it is more advantageous. It is generally only advantageous when the preferred shares have a cap on the potential value received from the liquidation or sale of the company.
Information Rights – A preferred shareholder may get special rights to information. This could include the ability to more closely monitor board and executive activity in the company.
Board Seats – Often preferred shareholders are allowed to vote for and elect a specific number of seats on the company board.
Approval Rights – The preferred shareholders may hold the right to approve or block specific company transactions (such as decisions to sell, merge, go public, etc.).
Participation Rights – Preferred shareholders often reserve their rights to participate as investors in subsequent rounds of investment.
Redemption Rights – The preferred shareholder may be able to force the company to redeem or repurchase their shares under certain conditions.
Registration Rights – The preferred shareholder may possess the authority to force a company to register the class of securities with the SEC and/or state regulators for public sale. This is just a short list of the major rights often afforded a preferred shareholder.
