Preferred equity is one of the unique types of equity that does not have any voting rights but pays scheduled dividends. It combines different aspects of bonds and common stocks. Holders of the preferred equity are prioritized over the common equity holders when it comes to dividend payments. In this blog, you will get to know about the impact of preferred equity on your equity value.


Preferred Equity

Features of Preferred Equity

In order to understand the impact of preferred equity, it is important to understand its features. Here are some of the most prominent features of preferred equity.

  • Preference in Assets

The holders of preferred equity are prioritized over the common equity holders upon liquidation of the assets. That means the preferred equity holders get the first preference to claim the assets of the company upon liquidation.

  • Non-Voting

The preferred equity does not provide the holders with the right to vote in company matters. However, there are certain preferred equity shares that allow the holders only to vote in some extraordinary events.

  • Dividend Payments

The preferred equity ensures scheduled dividend payments for the holders. The dividends are paid out before the dividends for common equity shareholders. The dividends of preferred equity are usually higher. The dividend rate can be a percentage of the shares’ par value or a fixed amount. 

  • Callability

The issuer of the preferred equity shares can repurchase the shares at specified dates.

  • Convertibility to Common Equity

Preferred equity can be converted into a predetermined number of equity shares. In the case of certain preferred shares, the date of converting the shares is specified. On the other hand, if the date is not specified, the shareholder will have to get the approval of the board of directors of the company to convert preferred equity into common equity.

Benefits of Preferred Equity

Preferred equity seems attractive to investors for a number of reasons. It proves to be beneficial for both the company and the investors. Some of the benefits of preferred equity are:

  • Fixed Income

The preferred equity has scheduled dividend payments. It provides the shareholders with a fixed source of income. 

  • Secured Position in the Company

Preferred equity allows the investors to get a secured position in the company in comparison to the common equity shareholders. In the event of liquidation, the preferred equity shareholders get priority to claim the assets over the common equity holders. 

  • Avoids Dilution of Control

One of the major benefits of preferred equity is that it does not dilute the control of the company. As it does not provide the holders with voting rights, the control over the company is not diluted.

Impact of Preferred Equity on the Value of Equity

Companies that provide preferred shares are likely to achieve a lower debt-to-equity ratio. This, in turn, allows the companies to get more financing in the future from different investors. Moreover, the debt-to-equity ratio of a company acts as an important metric for the analysis of the financial stability of the business. 

The issuance of the preferred equity is likely to have a significant impact on the equity of the stockholders. As the preferred equity shares can be converted into common equity shares, their value increases with the increase in the value of the common equity shares. 

Owing to the many benefits of preferred equity, most investors prefer investing in it as compared to common equity. When investing in preferred equity, it is important to remember that even though it provides steady dividends, it does not offer voting rights to the shareholders. 

Have you raised a recent round of preferred equity? Sharp 409A can help you determine the value of common shares for grating fresh employee stock options.

 

Topic: 409A Valuation