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Preferred Stock

Definition - What does Preferred Stock mean?

A preferred stock is a type of stock that has special features that differentiate it from common stock; it has the properties of both equity and debt instrument. It is a hybrid instrument that ranks higher than the common stock but is subordinate to debts/bonds in terms of claim.

A preference stock is also referred to as a preference share.

Divestopedia explains Preferred Stock

Preferred stocks have priority over common stock when it comes to payment of dividends and upon liquidation. They may be issued as cumulative, participating, or convertible as well as in any combination of these.

Convertibles have characteristics of both debt (fixed dividend) and equity (potential appreciation). Convertible preferred stock can be exchanged for a predetermined number of common stock shares. Almost all preference shares have a negotiated fixed dividend. If they have a cumulative dividend offer, the dividends accumulate and make up "dividend in arrears" if the firm fails to pay dividend.

In exchange for dividend preference, preferred stockholders rarely have any voting rights. As a result, they are usually not given the opportunity to vote in a buyout. Some preference shares may, however, provide special voting rights to approve extraordinary events, such as the issuance of new stocks, the acquisition of a firm, or the election of directors.

In the acquisition of a mid-market company, purchasers may use cash or other stock as consideration. The selling shareholder needs to be aware of the characteristics of consideration being paid to them. For example, preferred shares may be offered as consideration but may have characteristics that more closely resemble those of a debt instrument such as vendor financing.

Also, in a private equity recapitalization, a selling shareholder will need to review the proposed capital structure post-acquisition prior to closing. Preferred stock is favored as an investment choice by private equity firms because it allows dividend repayments to investors throughout the investment period. Exiting owners must feel comfortable that the post-closing capital structure is fair and equitable to all parties. This would include a detailed review and assessment of the valuation, risk and repayment terms associated with the different types of shares.

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