What are Participating Convertible Preferred Shares?

The class of equity demanded by investors in most venture capital financings is preferred convertible participating shares (PCP). As discussed in prior lectures, this class of shares has conversion rights to common stock. The shares will have both voluntary and mandatory conversion provisions. It also grants a liquidation preference with participation rights after return of the liquidation preference. 

The participation rights may be capped at a certain amount; otherwise, voluntary conversion rights would be largely irrelevant, as the value of the common stock would never eclipse the value of the preferred stock. There will always be a mandatory conversion provision in the equity instrument. As discussed in the convertible stock lecture, mandatory conversion provides comfort to later purchasers of shares that there is only one class of stock to consider. 

Continuing with the subject of participation rights, the nature of the shares may allow other shareholders to catch up before participations rights begin. In this situation, the terms may allow for unlimited participation rights.

How Participating Convertible Preferred Shares Are Applied

The PCP shares make venture-capital financing quite attractive because it offers a lot of benefits to venture capitalists. One of the benefits of PCP shares is that it confers on venture capitalists the right to convert the PCP shares to common stock when leaving an investment, it also gives these investors an assurance that they would get back the money they invested. 

A PCP stock also offers investors a form of security, in which they have the right to receive preferred dividends ahead of other shareholders of common stock. When the company is also being liquidated, venture capitalists or holders of PCP shares have the right to receive payments before other shareholders of common stock. 

In a liquidation, investors with PCP shares are entitled to the face value of their investment and the return for participating in the investment first, before all other shareholders are paid. Holders of PCP shares have the right to convert PCP shares to common stock at their discretion. This means they do not need to wait before a company is liquidated before the shares are converted.