Preferred Stock Definition and Legal Meaning
On this page, you'll find the legal definition and meaning of Preferred Stock, written in plain English, along with examples of how it is used.
What is Preferred Stock?
n.In a corporation priority given to a group of shareholders in payment of dividend which is a fixed percentage and does not depend upon the profits made or distribution of assets if the corporation is getting dissolved.They cannot demand higher dividend if the company makes higher profits and they dont exercise voting rights as they have minimum risk involved. ([source](https://studyfinance.com/preferred-stock-valuation/))
History and Meaning of Preferred Stock
Preferred stock is a type of stock that is issued by a company, which has a higher claim on the assets and earnings of the company when compared to common stock. The shareholders who invest in preferred stock usually have a fixed dividend that they receive on a regular basis, and this percentage does not depend on the profits made or distribution of assets. In case the company makes higher profits, preferred shareholders cannot demand higher dividends or vote in the shareholder’s meetings like common shareholders.
Preferred stock was created as a financial instrument for investors who were looking to receive a fixed stream of income and reduce their exposure to risk, as well as for companies that wanted to raise capital without diluting the control of their common shareholders. The amount of dividends paid to preferred shareholders is set at the time of issuance and remains constant unless the company specifically decides to increase the dividend payout. Companies also have the power to call back the preferred stock at its issuance price after a certain period of time.
Examples of Preferred Stock
- Company A issues 1,000 preferred stock shares with a face value of $100 and an annual dividend rate of 5%. This means that each preferred shareholder will receive $5 per year as a dividend, regardless of the profits made by the company.
- Investor B purchases 500 preferred stock shares of Company C, which has issued $10 million of preferred shares. Investor B is entitled to a priority on receiving payouts over investors who hold common stocks, but will have no voting rights in company decisions.
- Start-up D issues preferred stock to multiple angel investors to secure short-term funding, blocking the possibility of venture capitalists from diluting the company's control in the future.
Legal Terms Similar to Preferred Stock
- Common Stock - The most basic type of stock issued by a company, which provides investors with ownership in the company and voting rights.
- Treasury Stock - Shares of a company's own stock that have been repurchased and are being held by the company for future use or to reduce the number of outstanding shares.
- Stock Buyback - The process of a company buying back its own common or preferred shares from the public markets, reducing the number of outstanding shares and increasing the ownership percentage of existing shareholders.