Convertible Preferred Stock

This price, known as the conversion price, is equal to the purchase price of the preferred share, divided by the conversion ratio. After a predetermined date, the investor has the option to convert their preferred stock to common stock. Not only does this mean that they would then receive voting rights but also that they can potentially enjoy greater returns if the company enjoys success. Preferred stock and convertible debt agreements are the foundational agreements that startup investors use to structure their investments.

The investor receives the agreed dividends and, if the company fails, they have priority over common shareholders when assets are paid out. There are several reasons why an investor might choose to invest in One reason could be because they believe that the company’s common stock will appreciate significantly in the future, and they want to benefit from that potential upside. Another reason could be because they want the stability and income potential of a fixed-income security, but also want the potential for capital gains if the common stock performs well.

Benefits of convertible preferred stock

Par value is a value that’s assigned to preferred stock and which determines how much money the stock holder is entitled to receive if the company goes bankrupt. A recapitalization is accomplished when an entire class of stock is switched to another class by stockholder agreement (e.g., through voting).

Convertible Preferred Stock

It can be converted into the common stock of the company at the predetermined date and conversion ratio. If the company is doing extremely well, the preferred shareholders can convert their stock into common stock, taking advantage of the rise in the common stock price. The conversion ratio represents the number of common shares that shareholders may receive for every convertible preferred share. The conversion ratio is set by management prior to the issue, typically with guidance from an investment bank. For Acme, let’s say the conversion ratio is 6.5, which allows investors to trade in the preferred shares for 6.5 shares of Acme stock. Startup investors shoulder significant risk by financing new, unproven businesses.

Series A, B and C Convertible Participating Preferred Stock Information

However, a bond has greater security than the preferred and has a maturity date at which the principal is to Convertible Preferred Stock be repaid. However, the potential increase in the market price of the common is lacking for the preferred.

  • By buying Acme convertible preferred shares, the worst investors would ever do is receive a $4.50 annual dividend for each share they own.
  • Most preferred stock deals also include a mandatory conversion to common stock if the company undergoes a qualified initial public offering .
  • Frequent distinctions include the relative size of each series’ dividend and the order of preference for payments.
  • Exchangeable preferred stock—This type of preferred stock carries an embedded option to be exchanged for some other security.

Because the number of common shares increases while the value of the company remains the same, the value of existing shares goes down. In other words, the new common shares dilute the value of all the common shares, which drives down the share price.


Preferred stock can also be further divided into different types, including cumulative preferred, callable preferred, participating preferred, and convertible preferred. Preferred stock, unlike common stock, is typically given to investors in young companies, and the company and the investors negotiate the terms. Venture capitalists typically receive convertible preferred stock when they invest in a startup.

Convertible Preferred Stock

At this stage, there may be merit in considering the conversion of preferred stock to common shares . Thus, the conversion premium influences the price at which the convertible preferred stock trades in the market. A high conversion premium implies that the underlying commons shares are trading well below the conversion price and there is little possibility of a profitable conversion. In this case, the convertible preferred stock will act more like a bond and will be susceptible to changes in interest rates. Convertible preferred stock gives an investor a stream of income as well as potential ‘upside’ advantages.

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The convertible preferred stock allows him to exchange his illiquid investment for common shares that are hopefully increasing in value as your company grows. In the meantime, the investor is receiving a market rate of return through dividend payments. If the company does poorly, convertible preferred stockholders do not have to convert their shares to common stocks. Then, if the company goes bankrupt, they will be paid from whatever assets remain before common shareholders get a chance. So they have the chance to gain from a company’s success while still maintaining some protection from a company’s failure.

Convertible Preferred Stock

Voting rights – Common stockholders receive the right to vote on important matters of corporate policy including the election of individuals to the board of directors and the issuance of additional shares of stock. Preferred shareholders at startups usually receive these voting rights as well. Preferred sharesare typically the second class of stock issued by a corporation.

What Are Convertible Preferred Shares?

Your personal savings are depleted and you have asked the bank to increase your credit line. The banker was very impressed with your company’s potential but was concerned your company is undercapitalized. In other words, increased debt loads would over-leverage the company and increase its risk profile. Investors must consider whether a higher yield will compensate them with higher risks like equity security when exercising the convertible option. Capital AppreciationCapital appreciation refers to an increase in the market value of assets relative to their purchase price over a specified time period.

What happens when a convertible bond matures?

A vanilla convertible bond provides the investor with the choice to hold the bond until maturity or convert it to stock. If the stock price has decreased since the bond's issue date, the investor can hold the bond until maturity and get paid the face value.

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