Zero dividend preferred stocks sound kinda hypocritical. How can a stock be preferred when it gets you zero dividends? Gather 'round to hear the tale.
First: preferred stock. On its own, this usually is taken to mean that whoever buys preferred stock is guaranteed a fixed dividend, which takes priority over commonplace share dividends. It’s like flying business class for dividend-yielding stocks.
So...what about zero dividend preferred stocks? They’re also known as “capital shares,” and yes, it means that a dividend is not guaranteed. However, it does mean that they’ll earn income from capital appreciation, which is money made from an increase in price or value of company assets. It also usually means that these stockholders will get preferred treatment over normie stockholders if the company goes bankrupt. In some cases, zero dividend preferred stockholders may get a one-time payment when they cash out at the end of their investment term.
Makes you think about what “preferred” means besides the usual "gets dividends" definition. Just like flying business class can mean different things on different airlines. Do you put that hot towel on your hands, or your face? What if it was down some sweaty guy’s pants last? What does “preferred” really mean?
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Finance: What's the Difference Between C...54 Views
finance a la shmoop. what's the difference between common and preferred
shares? hmm well common versus preferred shares. the Smackdown. who would win well
in a fight near bankruptcy a financially stressed situation preferred shares win
hands-down. in the investing landscape there's a stack or priority list for who
gets paid what when. in the situation where a company is insolvent or [kid smiles and gives thumbs up]
basically goes bankrupt. that is you know nots on this storm and warm long .well in
the real world there's preferred common stock in both private companies and
sometimes in public ones . when private companies preferred is the dominant
initial investing vehicle. in public companies it's the opposite . why? well
because little tiny companies with two geeky techie kids in a garage in Palo
Alto are vastly more risky investment than those done in large public
companies like in coca-cola or Pepsi. when you buy shares of Apple today
you're buying common shares. ticker a APL this thing right here .so the priority
stack of who gets what when goes something like this- any cash left over
in a company liquidation meaning bankrupt so the auctioneers are just
selling it on eBay in parts. the first money goes to employees like we wrote a [cash in water]
paycheck. and then there's vendors and like a plumber an electrician who came
did work and never got paid for it. and then there's bank debt if there is any
collective paid next. then secondary loans from more risky than bank lenders
get paid like if venture debt is out there it's it's below bank debt. then
preferred shares get paid off in full then finally common shareholders get
paid if there's any money left over and there usually isn't. now in the hopes
dreams and whimsy of early-stage company investors called venture capitalists, all
of their companies do well grow fast and they go public. and usually at the IPO
all of the shares have preferred convert into one class of share called
common stock. and that's when things go well . that's what venture capitalist
dream about everything converts preferred becomes common, one class of [man looks excited as he holds pile of cash]
stock like a APL .but when things don't go so well it gets ugly.
well uglier. yeah alright let's walk through an example. big deal.com rates
four million bucks in venture capital. took out a 1 million dollar bank line of
credit which it fully drew down meaning actually borrowed a million dollars so
it's got five million bucks cash to working with and it has 200 grand in
builds owed to employees and vendors like Amazon Web Services Paddy's party
planning and Joe's five-second rule catering. the company is then sold as
scrap to a competitor for seven million dollars. so who gets what? well first the
employees and vendors get paid two hundred grand right off the top three
six point eight million left. then the million bucks from the bank credit line
gets paid. and if there was any BAC interest owed well that'd be in here as
well so we're down to five point eight million dollars left. then the four
million dollars of venture capital investment gets paid because it was in [equation]
preferred shares. that gets paid back to the venture guys who notably get all of
their money back even though the company did not do well. yeah so you'd ask why do
venture capital people get such a perk of getting their investment back first
the head of the common shareholders and the founders of the company? well because the
venture guys take a lot of risk and because many many many companies can't
even sell for the seven million dollars in scrap, so the four million that the
venture capital is put in often is worth well pretty much zero zilch zip. so the
investors have to be paid for the risk that they're taking when they invest
otherwise they just wouldn't invest as much and that's bad for everyone. after [investors smile]
this four million bucks is gone well they're swimming at one point eight
million dollars left and it's that amount that gets split among all the
other common shareholders. the founder owns 30% of the common at this point. so
she keeps five hundred forty grand. and the employees who had stock options and
other investors while they keep the rest. all kind of split up. in practice the
details make these transactions way way way more complex and there's lawyer
involved. sorry some term sheets from venture capitalists required that their
preferred be paid back twice before any common gets paid. so in this case the
four million dollars would have had to be eight million dollars paid back to
the venture guys before anything went to the common shareholders. there we've got [list of who gets paid what]
nothing right why would a founder take such abuse and what's called a 2x
liquidation preference? well the answer valuation. that is for a simple 1x or one
x just give us our money back and we'll move on kind of deal the valuation of
big deal com might be ten million dollars. but if the founder wants a
valuation of fifteen million dollars or more to stave off dilution from outside
investors. well she might give on key terms like liquidation preference
multiples because before the company's funded she's dreaming she's the next
Google right? and in the case of big deal commit mattered a lot. here the founder
leaves with over half a million dollars not bad for a failed company right? but
if they've negotiated for a higher valuation and the VCS had gotten a 2x [woman walks off with pile of cash]
liquidation preference well the founder would have left with nothing. the idea
here is that term sheets are complicated and there's an army of lawyers in
Silicon Valley who negotiate these things all day long. this all they do. so
I don't want to negotiate against them. got it ?there you go
common versus preferred shares. not a fair fight. check they're not even in the
same weight class. yeah all right moving on [cage fighter jumps up and down]
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