Participating Preferred Stock Definition
Preferred stock is a kind of stock that entitles the holder with a fixed dividend, whose payment enjoys the priority over that of ordinary share dividends.The participating preferred stock may also have the liquidation preferences on a liquidation event.
A Little More on What is Participating Preferred Stock
Participating preferred stock– similar to other kinds of preferred stock – takes preference in business’s capital structure over the common stock but remains below the debt in liquidation events. Moreover, in case of liquidation, participating preferred shareholders may also enjoy the right to get the stock’s purchasing price back and a pro rata share of the remaining proceeds that common shareholders get.
The liquidation event, whether the preferred stock of the investor is participating or nonparticipating, determines if the investor gets more consideration over the liquidation value of preferred stock and any dividends investor owes. If the preferred stock of the investor is participating, he is entitled to any value leftover after liquidation as if that stock had been common stock. On the contrary, the nonparticipating preferred shareholders get their liquidation value and dividends in arrears (if available), but they don’t have right for any other consideration.
Participating preferred stock is issued rarely, but one way where it is used is as a poison pill. In such case, present shareholders are given stock that grants them the right to new common shares at a bargain price in case of an undesired takeover bid.
Example of Participating Preferred Stock
Let’s say company A issues the participating preferred shares having dividend rate of $1 a share. The preferred shares bear a clause on additional dividends for the participating preferred stock that is triggered whenever dividend of common share will surpass the preferred shares.If, in the current quarter, the company makes an announcement to issue dividend of $1.05 per share for its shares, while the participating preferred shareholders will also get a dividend of $1.05 a share.
Now let’s think of a liquidation event. Company A possesses $10 million of preferred participating stock outstanding, which represents 20% of the capital structure of the company with the other 80%, or $40 million, consisted of common stock. Company A liquidates, and the proceeds are $60 million. The participating preferred shareholders will get $10 million but also would get 20% of the remaining proceeds, $10 million in this case (20% x $60 million – $10 million). Nonparticipating preferred shareholders will not get any additional consideration.
References for Participating Preferred Stock
Academic Research on Participating Preferred Stock
Participating Preferred Stock, Berle Jr, A. A. (1926). Participating Preferred Stock. Colum. L. Rev., 26, 303.
Contingent Payout Functions for Firms with Capped Participating Preferred Stock, Kaufman, J. (2012).
Modeling the conversion decisions of preferred stock, Harris, T. J. (2002). Bus. Law., 58, 587.
Participating convertible preferred stock in venture capital exits, Arcot, S. (2014). Journal of Business Venturing, 29(1), 72-87.
A theoretical model for valuing preferred stock, Emanuel, D. (1983). The Journal of Finance, 38(4), 1133-1155.
Corporations: Unorthodox Preferred Stock Provisions in Priority Litigation, Gilliom, E. R. (1937). Michigan Law Review, 36(1), 96-106.
Stock and Other Dividends as Income, York, T. (1940). The Accounting Review, 15(3), 380-393.