What are participating preferred shares?
Participating preferred shares are a type of preferred share that gives their holder the right to receive dividends equal to the rate usually specified that preferred dividends are paid to preferred shareholders, as well as an additional dividend based on a predetermined condition. Participating preferred shares may also have liquidation preferences during a liquidation event.
Key points to remember
- Participating preferred shares are preferred shares that pay both preferred dividends and an additional dividend to their shareholders.
- The additional dividend guarantees these shareholders a dividend equivalent to that of ordinary shareholders.
- Participating preferred shares are not common, but can be issued in response to a hostile takeover bid as part of a poison pill strategy.
Participating preferred shares
Participating preferred shares, like other forms of preferred shares, take precedence over a company’s capital structure over common shares, but rank below debt in the event of liquidation. The additional dividend paid to preferred shareholders is generally structured to be paid only if the amount of dividends received by common shareholders exceeds a specified amount per share. In addition, in the event of liquidation, the participating preferred shareholders may also be entitled to receive the purchase price of the share as well as a share of any remaining proceeds that the ordinary shareholders receive.
In the event of liquidation, the fact that the preferred share of an investor participates or not will determine whether this investor receives additional consideration compared to the liquidation value of the preferred share and of the dividends due to the investor. If an investor’s preferred share participates, that investor is entitled to any post-liquidation residual value as if it were a common share. Non-participating preferred shareholders, on the other hand, receive their liquidation value and any dividend in arrears, if any, but they are not entitled to any other consideration.
Participating preferred shares are rarely issued, but one of the ways they are used is the poison pill. In this case, the current shareholders receive shares which entitle them to new ordinary shares at a bargain price in the event of an unwanted takeover bid.
Example of participating preferred shares
Suppose that Company A issues participating preferred shares with a dividend rate of $ 1 per share. Preferred shares also include an additional dividend clause for participating preferred shares, which is triggered whenever the dividend for common shares exceeds that of preferred shares. If during the current quarter, Company A announces that it will pay a dividend of $ 1.05 per share for its common shares, the participating preferred shareholders will also receive a total dividend of $ 1.05 per share (1, $ 00 + 0.05).
Now consider a liquidation event. Company A has $ 10 million of participating preferred shares outstanding, representing 20% of the company’s capital structure, the remaining 80%, or $ 40 million, being common shares. Company A is wound up and the proceeds are $ 60 million. Participating preferred shareholders would receive $ 10 million, but would also be entitled to 20% of the remaining proceeds, $ 10 million in this case (20% x $ 60 million – $ 10 million). Non-participating preferred shareholders would not receive additional consideration.