What Is Participating Preferred Stock?
Let me explain participating preferred stock directly to you: it's a type of stock that gives shareholders the benefit of getting both the usual preferred dividends and an extra dividend when certain conditions kick in. This stock not only guarantees higher dividend payouts but also gives you preferences in liquidation situations, placing it above common stock but below debt in the company's capital setup. You'll find these features especially useful in strategies like poison pills to fend off hostile takeovers.
Key Takeaways
- Participating preferred stock lets shareholders earn a standard preferred dividend plus an additional one based on specific triggers.
- These shares sit higher than common stock in the capital structure but below debt, with liquidation preferences that can provide extra returns.
- The extra dividends for these stockholders usually depend on common shareholders getting a dividend over a certain level.
- You can use participating preferred stock strategically, like in a poison pill defense against unwanted takeovers.
- Though uncommon, participating preferred stockholders can share in liquidation proceeds, possibly getting more than nonparticipating ones.
Detailed Insights Into Participating Preferred Stock
Just like other preferred stocks, participating preferred stock ranks ahead of common stock in a company's capital structure but behind debt during liquidation. The extra dividend for these preferred shareholders is typically set up to pay out only if common shareholders' dividends go beyond a specific per-share amount.
In a liquidation, you as a participating preferred shareholder can recover your purchase price and also get a portion of any remaining proceeds. When liquidation happens, whether your preferred stock is participating or not decides if you get more than just the liquidation value and any owed dividends. Participating holders receive leftover value after liquidation, much like common stockholders do. Nonparticipating ones, however, only get their liquidation value and any back dividends, without extra consideration.
I should note that participating preferred stock isn't issued often, but it serves as a poison pill tactic. Here, existing shareholders get stock that lets them buy new common shares cheaply if there's an unwanted takeover attempt.
Scenarios Involving Participating Preferred Stock
Consider this example: Suppose Company A issues participating preferred shares with a $1 per share dividend rate. There's a clause for extra dividends that activates when common shares' dividends exceed the preferred ones. If Company A declares a $1.05 per share dividend for common shares in a quarter, you as a participating preferred shareholder would get $1.05 total per share—that's your $1.00 plus the extra $0.05.
Now, in a liquidation scenario, say Company A has $10 million in participating preferred stock, making up 20% of its capital, with the remaining $40 million in common stock. If the company liquidates with $60 million in proceeds, participating preferred shareholders get their $10 million back, plus 20% of the remaining $50 million, which comes to another $10 million. Nonparticipating preferred shareholders wouldn't get that additional amount. (Note: An earlier version had a calculation error in this example, corrected on Nov. 4, 2022.)
The Bottom Line
To wrap this up, participating preferred stock gives you as an investor the edge of standard preferred dividends plus extras when conditions are met. These shares rank over common stock in the capital structure but under debt. In liquidations, you might get your purchase price back plus a share of remaining proceeds. While it's not commonly issued, it works as a strategic defense against hostile takeovers. Make sure you understand the specific terms, as they directly affect your potential returns and rights in liquidation events.
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