What Is a Participating Preferred Stock?

Participating preferred stock is a symmetry of "non-participating preferred stock". When corporate profits increase, in addition to enjoying the established dividends, shareholders can also participate in the distribution of preference shares with ordinary shareholders. There are two types: all participate in preferred shares, shareholders have the right to share the current period's surplus with ordinary shareholders, and there is no upper limit on their earnings; for partial participation in preferred shares, shareholders have the right to share the period with ordinary shareholders Surplus, but its earnings are capped. ^[1]

Participation in preferred stock

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Without a description of a new and better tool in venture financing-participation in preferred stocks, the description of the typical preferred stocks obtained by venture capitalists will not be complete. If convertible preferred stock is used as an optional tool, when the entire company sells and exits, the holder can choose to hold the preferred stock and obtain liquidation preference and accumulated dividends, or convert to share the gains as profits increase . For example, if a venture capital fund invests US $ 5 million in a form of convertible preferred stock, which accounts for 50% of its shares (that is, convertible into 50% of ordinary shares), and the company pays US $ 5.5 million If it is sold, then the shareholders of the preferred stock may obtain benefits that ordinary shareholders (such as entrepreneurs) cannot share because they hold the stock. However, if the company sells for well over $ 10 million, it is worth converting the convertible preference shares into common shares to share 50% of the sale amount. On the other hand, the change in participating preferred stocks is "have your cake and eat it too". Therefore, it can be said that although dividends are often not paid in the current period, but accumulated and added to the liquidation preference like convertible preference shares, participating preference shares are also pure preference shares that can share dividends. However, shareholders participating in preferred stock will also benefit from the conversion of common stock, that is, for the same $ 5 million investment, investors can get pure preferred stock with a liquidation priority of $ 5 million, plus 50% Common stock. Such securities, as it is sometimes called, become "bundles" or "units" of securities. If the company in the above example was sold for $ 12 million, the shareholders participating in the preferred shares would not convert the shares into ordinary shares and receive a gain of $ 6 million, and the other 6 million would be shared by the common shares, but the $ 5 million cost Gold plus accrued dividends, say $ 500,000, and then share 50% of the remaining $ 6.5 million. As a result, shareholders of common stock are not earning $ 6 million, but only $ 3.25 million. If the IPO method is adopted, after dilution in the IPO, the participating shareholders can still recover the principal and accrued dividends, and then hold 50% of the ordinary shares. If the amount of asset settlement is hundreds of millions of dollars, participate in preferred shares The fact that shareholders withdraw the original $ 5 million will not have a material impact on the internal rate of return for ordinary shareholders. However, if the amount is in the tens of millions of dollars, the difference in earnings between participating preference shareholders and ordinary shareholders will be significant.