There
are several types and/or classes of stocks that can be issued by a corporation.
The two most used are called
common and
preferred. Common stock is given no priority or preference over other
classes of stock. Stockholders of common stock have the right to buy and sell
those stocks as set forth in the corporation’s articles. They are allowed to
cast votes in accordance with the number of shares held (i.e. one share equals 1
vote). In short, stockholders holding common stock generally have the same
rights and privileges given all shareholders, and more specifically have the
benefits of capital appreciation and dividends.
If you
were to compare stocks to horses, you would likely view common stocks as the
workhorse of stocks. Corporation tend to use these types of stocks more
frequently as they get the job done in terms of raising needed capital
investment while ensuring the stockholder is granted certain rights and
privileges as set forth in the
articles of incorporation and by applicable state laws.
Preferred could be likened more to that of a thoroughbred racing horse.
While these horses could probably do the same things as a workhorse, an owner
would likely reserve the use of the thoroughbred as a racehorse because the
owner holds that horse in higher regards when it comes to his ability to win a
race.
As the
owner of the racehorse probably paid a premium to buy, own and race that horse,
so will the holder of preferred stocks. Preferred stockholders have certain
rights and privileges that set them apart from common stocks. For instance,
preferred stocks do not have the same potential for profit as a common stock,
but they are more stable because they usually guarantee that the holder will
receive a regular dividend payment of some sorts that is not tied to the market,
like the price of common stocks are. Prices for preferred stocks are usually
tied to interest rate levels and tend to go up and down as rates do. For the
privilege of this added security and stability, shareholders are often willing
to pay a higher premium. These additional safeguards are why many
professional investors such as venture capitalists often like preferred to
common stock
when investing in a corporation.
There are several types of preferred stocks such as:
participating preferred stock
– dividends on these types of stocks tend to increase, if during the year,
common stock dividends exceed preferred.
adjustable-rate preferred
– tied to Treasury bills (T-bills) or other rates, dividend payouts on these are
usually based on the shifts in interest rates and are set by the corporation on
a pre-determined formula.
convertible preferred
– when issued, a price for conversion is set so that they can later be converted
to company stock at a set rate.
Straight or fixed rate
perpetual stock –
no maturity date is listed for these stocks because dividend rates are set for
the life of the stock’s issue.
It is
not uncommon to find companies, intending to go through multiple rounds of
financing, to issue multiple classes of preferred stock. Privately owned
companies tend to favor the use of preferred stocks, especially if they want to
separate stockholder interest. Another things to remember is if you intend to
take your company public, the SEC and other governing bodies tend to frown upon
preferred stocks being issued.
Your
decision to issue one or several classes of stock is usually based on how
attractive your shares may be to potential investors. If you believe shares of
common stock will sell well enough to raise the needed capital, there really is
little reason to authorize the issuance of other classes of stock. However, you
may find that some investors may insist that their stock be given “special
preference”, i.e. dividends, voting or liquidation rights that distinguish them
from common stock holders.
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