What is participating preferred stock?

Participating preferred stock is a type of preferred stock that gives the holder the right to receive dividends equal to the customarily specified rate that preferred dividends are paid to preferred shareholders, as well as an additional dividend based on some predetermined condition.

Participating preferred stock can also have liquidation preferences upon a liquidation event.

Participating Preferred Stock

Participating preferred stock, like other forms of preferred stock, takes precedence in a firm's capital structure over common stock but ranks below debt in liquidation events. The additional dividend paid to preferred shareholders is commonly structured to be paid only if the amount of dividends that common shareholders receive exceeds a specified per-share amount.

When there is a liquidation event, whether an investor's preferred stock is participating or non-participating will determine if that investor receives additional consideration over the liquidation value of the preferred stock and any dividends owed to the investor.

If an investor's preferred stock is participating, that investor is entitled to any value leftover post-liquidation as if that stock had been common stock. Non-participating preferred shareholders, on the other hand, receive their liquidation value and any dividends in arrears if applicable, but they are not entitled to any other consideration.

Preferred and Common stock

Preferred and common stock have varying claims to income which will change from one equity issuer to another. In general, preferred stock will be given some preference in assets to common assets in the case of company liquidation, but both will fall behind bondholders when asset distribution takes place. In the event of bankruptcy, common stock investors receive any remaining funds after bondholders, creditors (including employees), and preferred stock holders are paid.

As such, these investors often receive nothing after a bankruptcy. Preferred stock also has the first right to receive dividends. In general, common stock shareholders will not receive dividends until it is paid out to preferred shareholders. Access to dividends and other rights vary from firm to firm.

Preferred stock may or may not have a fixed liquidation value (or par value) associated with it. This represents the amount of capital that was contributed to the corporation when the shares were first issued.

Preferred stock has a claim on liquidation proceeds of a stock corporation equal to its par (or liquidation) value, unless otherwise negotiated. This claim is senior to that of common stock, which has only a residual claim.

Both types of stock can have a claim to income in the form of capital appreciation as well. As company value increases based on market determinants, the value of equity held in this company also will increase.

This translates to a return on investment to shareholders. This will be different to common stock shareholders and preferred stock shareholders because of the different prices and rewards based on holding these different kinds of shares. In turn, should market forces decrease, the value of equity held will decrease as well, reflecting a loss on investment and, therefore, a decrease on the value of any claims to income for shareholders.

Voting Right

Common stock generally carries voting rights, while preferred stock does not, however, this will vary from company to company.

Example of Participating Preferred Stock

Suppose Company A issues participating preferred shares with a dividend rate of R1 per share. The preferred shares also carry a clause on extra dividends for participating preferred stock, which is triggered whenever the dividend for common shares exceeds that of the preferred shares. If during its current quarter, Company A announces that it will release a dividend of R1.05 per share for its common shares, the participating preferred shareholders will receive a total dividend of R1.05 per share (R1.00 + 0.05) as well.

Now consider a liquidation event. Company A has R10 million of preferred participating stock outstanding, representing 20% of the company's capital structure with the other 80%, or R40 million, made up of common stock. Company A liquidates, and the proceeds are R60 million.

The participating preferred shareholders would receive R10 million but also would be entitled to 20% of the remaining proceeds, R10 million in this case (20% x R60 million - R10 million). Non-participating preferred shareholders would not receive additional consideration.

What happens if you own preference shares in a company that goes bankrupt?
If a company goes bankrupt, then the different security holders in that company will have claim to the company’s assets. The order in which those security holders receive their share of the assets will depend on the specific rights given to them in their security agreements.

Preference shares, for instance, will generally have priority over the common shares, and will therefore be paid before the common shareholders. However, preference shares will generally have lower priority than corporate bonds, debentures, or other fixed-income securities.

Key takeaways
• Participating preferred stock is akin to preferred shares that pay both preferred dividends plus an additional dividend to their shareholders.

• The additional dividend ensures that these shareholders receive an equivalent dividend as common shareholders.

• Participating preferred stock is not common but can be issued in response to a hostile takeover bid as part of a poison pill strategy.

What is participating preferred stock? What distinguishes it from non- participating preferred stock?
As the name indicates, holders of preferred stock get preferential treatment; in a sale, they typically get paid first, before holders of common stock. When there is not enough money to go around to pay back the preferred stockholders’ investment, the preferred stockholders get everything.

When there is enough to pay back all preferred stockholders with additional money left to distribute to other stockholders, whether the preferred stockholder is participating or non-participating will determine how the rest of the money is distributed.

Participating preferred stock holders are entitled to receive a share of any remaining liquidation proceeds on an as-converted to common stock basis, after they have already gotten back their liquidation preference, whereas non-participating preferred stock holders either get:

(i) their liquidation preference back; or
(ii) the amount they would have gotten had they converted to common stock. In other words, participating preferred gets its cake, and gets to eat it too.