Login
Copyright

Participating Preferred Stock: Definition & Example

Instructor: Mark Koscinski

Mark has a doctorate from Drew University and teaches accounting classes. He is a writer, editor and has experience in public and private accounting.

In this lesson, you will learn how dividends and liquidation proceeds are distributed to participating preferred stock shareholders. We will also discuss why venture capital firms use this financing vehicle to raise funds.

Participating Preferred Stock

Imagine owning a business in need of a capital infusion to support growth. You have engaged a venture capital (VC) firm for some creative solutions to your problem. After providing the VC with all the requested information they prepare a financing proposal for your review.

Participating Preferred Stock

In this situation, the VC might propose using participating preferred stock to raise the much-needed funds for your company. Participating preferred stock differs from common stock in several significant ways. Shareholders usually do not vote, but they do receive preferred dividends. Preferred stock normally carries a par value and a stated dividend rate based on that par value. So, for instance, a preferred stock issue with a $100 par and a 7% dividend rate should receive annual dividends of $7 per share.

Participating preferred stock receives not only its contractually required dividend, but also may receive additional dividends based on predetermined conditions. Common stock cannot receive any dividends prior to the preferred stock receiving all of its required dividends. The participation in the common stock dividend is an additional incentive for an investor to fund your company. The investor not only receives the stated dividend, but also participates in the 'upside' the common stock might experience.

Example of Participating Dividends

Suppose your company issues preferred stock with a 10% dividend rate and a $100 par value. Each share of preferred stock is entitled to receive dividends of $10 in the current year. Your company has done well and not only pays the preferred stock dividend, but also can afford an $11 per share common stock dividend. A non-participating preferred stock would receive a dividend of just the contractually required $10 per year. A participating preferred stock would 'participate' with the common stock and receive up to an additional $1 per share dividend based on the participation provisions of the preferred stock. A participating preferred has 'upside protection' and will receive an additional dividend if the common stockholders receive a dividend.

Corporate Liquidation

Preferred stock always has a liquidation preference over common stock. In a liquidation or bankruptcy debtors are paid first, followed by the preferred stock shareholders and then the common stockholders. So, in our example each outstanding share of non-participating preferred stock would receive its par value prior to the common shareholders getting paid, or $100. In addition, the preferred stockholders would receive any dividends due to them.

A participating preferred receives its par value back in liquidation, but also receives a portion of the proceeds received by the common stock shareholders. Suppose in our example, the common shareholders receive liquidating dividends of $80 per share and the preferred stock calls for payment of not only its par but also the same amount a share of common stock receives. In this situation, a share of preferred stock would receive a dividend of $180.

To unlock this lesson you must be a Study.com Member.
Create your account

Register for a free trial

Are you a student or a teacher?
I am a teacher
What is your educational goal?
 Back

Unlock Your Education

See for yourself why 10 million people use Study.com

Become a Study.com member and start learning now.
Become a Member  Back

Earning College Credit

Did you know… We have over 95 college courses that prepare you to earn credit by exam that is accepted by over 2,000 colleges and universities. You can test out of the first two years of college and save thousands off your degree. Anyone can earn credit-by-exam regardless of age or education level.

To learn more, visit our Earning Credit Page

Create an account to start this course today
Try it free for 5 days!
Create An Account
Support