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Preferred Stock - Explained

What is Preferred Stock?

Written by Jason Gordon

Updated at April 5th, 2023

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Back To: BUSINESS ENTITIES, CORPORATE GOVERNANCE, & OWNERSHIP

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. 

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