What is Participating Preferred Stock?
Participating preferred stock is a type of preferred stock that provides the holder the right to receive dividends at a specified rate similar to other preferred dividends paid to preferred shareholders. Additionally, holders may receive an extra dividend based on predetermined conditions. Participating preferred stock also often includes preferences in liquidation events.
Key Benefits
- Participating preferred stock combines the benefits of preferred shares paying regular dividends with an additional dividend when certain conditions are met.
- These shareholders may receive equivalent or greater dividends compared to common shareholders under specific conditions.
- While rare, participating preferred stock can be used as a strategy to thwart hostile takeover attempts.
Understanding Participating Preferred Stock
Participating preferred stock, much like other forms of preferred stock, is superior in a company’s capital structure to common stock but ranks below debt in liquidation scenarios. The structure commonly stipulates that extra dividends are paid out when dividends for common shareholders surpass a specified per-share amount.
In the event of a liquidation, participating preferred shareholders have the right to receive the stock’s purchase price back and a pro-rata share of any remaining proceeds, similar to what common shareholders receive.
The nature of a liquidation event means that whether an investor holds participating or nonparticipating preferred stock will dictate if additional value—beyond the stock’s liquidation value and owed dividends—is received. With participating preferred stock, the investor is entitled to any remaining value post-liquidation in a manner similar to common stock. Nonparticipating preferred shareholders, however, receive only the liquidation value and due dividends without further consideration.
Although participating preferred stock is rarely issued, one notable use is as part of a poison pill strategy, granting shareholders the right to purchase common shares at a significantly reduced rate in the event of an unfriendly takeover attempt.
Real-World Example of Participating Preferred Stock
Example Scenario
Imagine Company A issuing participating preferred shares with a dividend rate of $1 per share. These shares come with a clause triggering extra dividends whenever common share dividends surpass those of preferred shares. Suppose, in the current quarter, Company A announces a $1.05 per share dividend for its common shares. Consequently, participating preferred shareholders will also receive a total dividend of $1.05 per share (comprising the base $1.00 plus an additional $0.05).
Liquidation Event
Suppose Company A liquidates with $10 million outstanding in participating preferred stock and $40 million in common stock, summing to a $50 million capital structure. The company’s total liquidation proceeds amount to $60 million. Participating preferred shareholders, entitled to their $10 million plus 20% of the residual proceeds after settling the preferred payment, will receive an additional $10 million (20% of $50 million). Thus, their total liquidation received is $20 million. On the other hand, nonparticipating preferred shareholders would get no extra post-liquidation consideration except their owed dividends, if applicable.
Related Terms: Preferred Stock, Common Stock, Dividends, Liquidation Event, Poison Pill.
