Updated July 10, 2023
Definition of Participating Preferred Stock
Participating in Preferred Stock is a preference share in which dividends are paid before payment to equity shares. In the event of liquidation also, they are given priority in repayment over common stockholders.
In addition, they may participate in the decisions in general meetings and have the right to vote just like common stockholders based on the terms of the issue.
Explanation
It is the type of stock where the preference is given to the preferred stockholders, whether it is dividend payment or payment at the time of liquidation. They can also be allowed to liquidate or convert into common stock. It is the same as the normal stock and may get the same rights as common stockholders based on the terms of the issue they are offered with the additional advantages like preference over common stockholders. Like common stock, it represents the partial ownership of the organization. The dividend paid to preferred stockholders is fixed and not fluctuating like that of equity stockholders. The dividends often are cumulative, i.e., entitled to receive dividends every year irrespective of profits earned. Still, if the company fails to pay dividends on the same in any year, the dividend gets accrued until its payment. But the organization can also issue non-cumulative preference stock.
Example of Participating Preferred Stocks
An Ltd. issue the participating preferred stock, 10% participating cumulative preferred stock of $ 100,000 representing 10%, 1,000 preference stock of $ 100 each. The company also has 10,000 equity shares of $ 100 each. The organization suffered a loss of $ 10,000 in 2019-20 and earned a profit of $ 100,000 in 2020-21. In addition, the company declares a dividend of 7% in 2020-21. Show the calculations of how much dividend is paid to the preference and equity stockholders.
Solution: In 2019-20,
As the organization suffered a loss in 2019-20, the dividend on preferred stock is to be accrued because of its cumulative nature and not to be paid because of loss. In 2020-21, As the organization suffered the loss in 2019-20, the loss is first set off from the profit of 2020-21, and then the dividend is to be paid.
Calculations are as under:
| Particulars | Amount ($) |
| Profits of 2020-21 | |
| Less: Set-off of loss of 2019-20 | |
| Remainder | 90,000.00 |
| Less: Preference dividend of 2019-20 | |
| (100000*10%) | -10,000.00 |
| Less: Preference dividend of 2020-21 | |
| (100000*10%) | -10,000.00 |
| Less: Equity dividend of 2020-21 | |
| (1000000*7%) | -70,000.00 |
| Net profit Transferred to the Balance sheet | – |
Importance of Participating in Preferred Stock
Some of the Importance are mentioned below:
- Participating preference stock holders get the preference at the time of dividend and at the time of liquidation or winding up of the organization.
- Participating preference stock holders get the fixed dividend, which assures the investors that they surely get the returns on investment.
- In the case of participating preferred stocks, the dividend is cumulative, i.e., participating preferred stock holders get the return irrespective of profits earned.
- Participative preference stockholders also get the right to additional earnings of the organization.
Participating Preferred Stock vs Non-Participating Preferred Stock
- As the name suggests, participating in preferred stock is the type of stock where the stockholders can participate in the company’s decisions. Still, the decisions the stockholders can participate in are per the terms of the issue. In contrast, Non-Participating Preferred Stock is the preferred stock where the stockholders do not get the right to participate in the company’s decisions.
- Participating preferred stockholders are given an option to convert their shares into equity shares. In contrast, Non-Participating preferred stockholders do not get such option of conversion of preferred stock into equity shares.
- Participating preferred stockholders can participate in the additional earnings of the company, whereas Non-Participating preferred stockholders do not get the same right.
- Participating preferred stockholders are given priority over the non-participating stockholders.
Advantages
Some of the advantages are mentioned below:
- Participating preference holders are given priority over the equity stockholders.
- Participating preference stockholders get assured dividends.
- Participating preference stockholders are more attractive to the investors.
- Participating preference stockholders can sell the stock at the market price above the issue price.
- Holders may get voting rights similar to the equity stockholders.
- The returns earned are quite higher than the non-participating stockholders.
Disadvantages
Some of the Disadvantages are mentioned below:
- Participating preference stock carries a high rate of dividend than the debentures, proving costly to the organization.
- Dividends in the case of participating preferred stock are cumulative; hence the cost is fixed irrespective of the profits.
- Participating preference stock is liquid in nature, unlike the equity stock, where repayment is made on the winding up of the company.
- The participating preference stock gets limited voting rights depending upon the company’s policies and terms of issue.
- Due to participating preferred stock, the dividend of equity shares gets affected.
- In the long run, it may lead to insolvency of the organization due to the heavy cost involved.
- The dividend on participating preferred stocks is not entitled to tax benefits like debentures, so sometimes debentures are better than the Participating preferred stocks.
Conclusion
Participating preference stock is where the stockholder gets the priority at the time of repayment of the amount and dividend payment. Participating preferred stockholders might get the rights to participate in the company’s decisions just like the equity shareholders, but there are limitations on the decisions they can participate in. In the case of Participating preferred stock, the dividend is cumulative; hence, they are accrued irrespective of profits earned. Participating preference stock is different from non-participating preference stock as the shareholders of non-participating preference stock do not get the right to participate in the decisions of the meeting. The cost involved in the case of participating preferred stock is very high, and the company is also not entitled to tax benefits. Hence, sometimes debentures are preferred over the Participating preferred stock.
Recommended Articles
This is a guide to Participating in Preferred Stock. Here we also discuss the definition and example along with advantages and disadvantages. You may also have a look at the following articles to learn more –
