Stock Rights & Warrants: Ownership, Voting Rights & Restrictions

Instructor: N. Faye Angel

Faye has taught college classes in Business and Information Systems programs, and has a Ph.D. in Technical Education and an M.B.A. in Business Administration.

What are the rights of stockholders of common stocks vs preferred stocks? This lesson will cover the differences and go over warrants and preemptive rights.

Stock Differences

Jesse has $1,000 to invest. She has a basic understanding of stocks, but should she buy common stock or preferred stock? She decides to look at their characteristics and safeguards.

Both can be privately or publicly owned. By issuing stock, the company increases equity, meaning it earns funds for expansion, special projects, products, locations, marketing, and production. A stockholder like Jesse owns a fraction or portion/percentage of the company.

For example, Jesse buys stock in Enjoy Music, Inc., which results in equity increasing to $50,000 ($49,000 + $1,000). Now Jesse owns 2% of Enjoy Music, Inc. Her wealth is increased by receiving dividends (from profits of Enjoy Music, Inc.) or earnings from capital gains (a significant increase in the selling price of the stock). However, the two types of stock have different characteristics.

Common vs preferred stock
common stock and preferred stock

Common Stock

Common stock is considered equity, gives the holders a say in management, and has a maturity date. Holders or investors like Jesse are often considered the 'real' owners. Issuing common stock would help Enjoy Music, Inc. raise needed money by providing equity, while the investors receive no guarantees of receiving any monetary returns.

Jesse, as a common stockholder, would have voting rights by contributing to the election of the Board of Directors and developing corporate policy for Enjoy Music, Inc. That would allow her to have a say in management. Generally, one share of common stock equals one vote.

If Jesse had only a few shares, she may turn her votes over to a proxy, another stockholder, to represent her. Common stock may not earn dividends or have capital gains. It does not have a maturity date, nor can some of the safeguards (warrants and some restrictions) of preferred stockholders apply to common stock.

Common stock is considered the riskiest because Jesse would be the last to be paid if the company is liquidated and its assets sold to cover its financial obligations. All Jesse could lose is her $1,000 investment. Nothing is guaranteed with common stock.

Preferred Stock

Preferred stock is also considered equity and does not have a maturity date, but offers companies more flexibility. Unlike common stock, it has a fixed payment called dividends, and if Jesse purchased preferred stock, she would receive fixed or guaranteed dividends.

For example, if the fixed dividends were $3.50 per share, and Jesse held 50 shares, she would receive annual dividends of $175 paid quarterly ($43.75 paid four times a year). However, she would have no voting rights and no say in management.

Like common stockholders, Jesse cannot lose more than her investment in Enjoy Music, Inc. Preferred stock is considered less risky because stockholders are paid before common stock dividends if the company liquidates.

These differences between the two lead some stockholders to think that preferred stock has advantages over common stock.

Warrants

Warrants are stock rights and literally defined as 'endowed with the right'. Generally, warrants are issued by the company and there are different types, but we'll just stick to traditional ones for this lesson.

Investors like Jesse holding preferred stock have the opportunity to purchase common stock at a predetermined price within a certain period of time. This is referred to as exercising the warrant. When the market price of the common stock is higher than the warrant exercise price on the preferred stock, a profit can be made on exercising the warrant.

Frequently, warrants are attached to preferred stock as a 'sweetener' to encourage investors to purchase the preferred stock because it may result in lower dividends paid by the company. However, warrants do not earn money until they are turned into common stock. They generally have an expiration date.

If the preferred stock with a warrant is not used to purchase common stock before this date, the investor no longer holds this right to exercise it. Warrants attached to preferred stock have a price and can be sold, usually on one of the stock exchanges - these are called warrant price. Generally, these transactions should be completed by a broker.

Here is a simplified example of exercising a warrant for preferred stock issued by Enjoy Music, Inc:

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When the warrant exercise price reaches a value of $45.00, the warrant allowing for purchase of common stock can be exercised. Jesse would also need the price of the warrant, which is $5.00. She'll need $50.00 per share to breakeven.

If the warrant is exercised on May 19, 2021, she may make $10.00 per share exercising the right and reselling the stock in the secondary market. Jesse's profit would vary depending on several conditions associated with the warrant.

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