What are the pros and cons of issuing preferred stock versus common stock?

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If you are a treasury manager looking for equity financing sources and methods, you may have to choose between issuing preferred stock or common stock. Both types of shares have advantages and disadvantages for your company and your investors. In this article, we will explain what preferred stock and common stock are, and compare their pros and cons in terms of dividends, voting rights, risk, and cost of capital.

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Elmer Dispo, CTP

Ex-Google, Ex-Twitter | Dynamic Treasury Professional | Investment Portfolio Management | Electronic Banking | FX Risk…
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??FCA | ??M.Com (F&T) | ??16x LinkedIn Top Voice | ???Information System Auditor | ??Certified Forensic Accountant…
Prem Kumar, ACA

Senior Manager Treasury Assurance Deloitte ???? 40k LinkedIn & 37k YouTube ?? Views are personal

1 What is preferred stock?

Preferred stock is a type of equity that gives its holders a fixed dividend payment before any dividends are paid to common stockholders. Preferred stockholders also have a priority claim on the company's assets in case of liquidation. However, preferred stockholders do not have voting rights or share in the company's growth potential. Preferred stock can be cumulative, meaning that any missed dividends are accumulated and paid later, or non-cumulative, meaning that any missed dividends are forfeited. Preferred stock can also be convertible, meaning that it can be exchanged for common stock at a predetermined ratio, or non-convertible, meaning that it cannot be converted.

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Exploring the nuances between issuing preferred stock and common stock can shed light on a company's strategic financing decisions. Preferred stock offers advantages like priority dividends and potentially greater security for investors, while common stock provides voting rights and a stake in company growth. However, it's crucial to weigh these benefits against the potential drawbacks, such as the fixed dividend obligations of preferred stock and its impact on financial leverage. Understanding the unique implications of each type of stock is essential for informed decision-making in corporate finance.

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Prem Kumar, ACA

Senior Manager Treasury Assurance Deloitte ???? 40k LinkedIn & 37k YouTube ?? Views are personal
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Preferred stocks can carry the risks of both common stock and debt based on their conversion criteria in future and are typically tax advantageous as against debt in terms of interest payments in some jurisdictions.

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James Kelly

I help multinational treasury teams to master AI and cash flow, through practical, hands on coaching | Experienced FTSE100 Treasurer
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Preferred stock is often issued in conjunction with common stock thereby offering equity holders a mix of risk profiles - the knowledge that preferred stock will be paid first but without voting rights and the value of common equity with the ability to shape the future of the company. The other time that preferred stock may be issued is on conversion of a derivative or loan due to a financial trigger being activated.

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2 What is common stock?

Common stock is a type of equity that gives its holders a residual claim on the company's earnings and assets after paying preferred stockholders and creditors. Common stockholders also have voting rights and can elect the board of directors and influence major corporate decisions. However, common stockholders do not have a fixed dividend payment and may receive nothing if the company does not generate enough profits. Common stockholders also bear the highest risk of losing their investment if the company goes bankrupt. Common stock can be classified into different classes, such as Class A and Class B, with different voting rights and dividend policies.

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Susie Cook, FCPA

Group Treasurer | Change Agent | Corporate Finance | Risk Management | Financial Reporting | Mergers & Acquisitions
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Holding common stock gives you a say in the company's direction but also the highest risk, as you're paid after creditors and preferred stockholders in bankruptcy. The potential for capital appreciation is significant; early investors in Apple or Google saw massive gains. Common stock can have different classes, such as Class A and Class B, balancing control and investment appeal. Class A might offer more voting power, attracting strategic investors, while Class B can appeal to those focused on financial returns. This flexibility helps tailor the investment proposition to diverse investor profiles, enhancing the company’s ability to raise capital effectively.

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3 Pros and cons of issuing preferred stock

Issuing preferred stock has some benefits for your company and your investors. For your company, preferred stock can improve your credit rating and reduce your cost of debt, as preferred stock is less risky than common stock for lenders. Preferred stock can also help you retain control of your company, as preferred stockholders do not have voting rights. For your investors, preferred stock can provide a steady income stream and a lower risk of capital loss, as preferred stockholders have a preference over common stockholders in dividends and liquidation. Preferred stock can also offer some flexibility, as you can issue convertible or callable preferred stock to adjust to changing market conditions.

However, issuing preferred stock also has some drawbacks for your company and your investors. For your company, preferred stock can increase your cost of equity, as preferred stockholders demand a higher dividend rate than common stockholders. Preferred stock can also limit your financial flexibility, as you have to pay preferred dividends before paying common dividends or reinvesting in your business. For your investors, preferred stock can limit their upside potential, as preferred stockholders do not share in the company's growth or appreciation. Preferred stock can also expose them to dilution risk, as you can issue more shares or convert preferred stock to common stock without their consent.

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Elmer Dispo, CTP

Ex-Google, Ex-Twitter | Dynamic Treasury Professional | Investment Portfolio Management | Electronic Banking | FX Risk Management | Treasury Automation | Banking Strategy & Operations | SAP S4 Hana Integration
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It's worth noting that issuing preferred stock presents advantages such as lower volatility, providing a more stable investment option for conservative investors. With their priority in liquidation and dividend preference, preferred stocks strike a balance between the riskier common stocks and more secure debt instruments. This lower volatility makes them an appealing choice for investors seeking a steady income stream while mitigating the risks associated with market fluctuations. However, disadvantages include the callable feature, potentially limiting returns if the issuer repurchases the stock at a preset price. In liquidation, preferred stocks are riskier than debt holders due to a lower claim on assets.

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Mohamed KORTAM, CFA?, CTP?, CMA?

Regional Treasurer Africa and Middle East | Working Capital Management | Capital Budgeting | Debt Funding | Financial Risk Management.
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From the perspective of the company and common shareholders. Pros: 1.Not perceived as debt, hence lower leverage. 2. No voting rights, hence no loss of control. Cons: 1. Dilution of ownership for existing shareholders. 2. Higher seniority vs. Common stock in case of liquidation. 3. Higher cost due to cumulative dividends which is not tax deductible vs. Debt.

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4 Pros and cons of issuing common stock

Issuing common stock also has some benefits for your company and your investors. For your company, common stock can lower your cost of equity, as common stockholders accept a lower dividend rate than preferred stockholders. Common stock can also increase your financial flexibility, as you do not have to pay common dividends unless you have sufficient earnings. For your investors, common stock can offer them a higher return potential, as common stockholders benefit from the company's growth and performance. Common stock can also give them a voice in the company's governance, as common stockholders have voting rights and can influence corporate policies.

However, issuing common stock also has some disadvantages for your company and your investors. For your company, common stock can dilute your ownership and control, as common stockholders have a claim on your earnings and assets. Common stock can also increase your risk of hostile takeover, as common stockholders can sell their shares to potential acquirers. For your investors, common stock can expose them to a higher risk of volatility and loss, as common stockholders bear the brunt of the company's failures and downturns. Common stock can also create agency problems, as common stockholders may have conflicting interests with the management or other stakeholders.

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Susie Cook, FCPA

Group Treasurer | Change Agent | Corporate Finance | Risk Management | Financial Reporting | Mergers & Acquisitions
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Issuing common stock has several additional pros and cons. On the positive side, it can enhance brand visibility, provide significant funds for growth and acquisitions, and offer liquidity as shareholders can trade shares in the secondary market. Additionally, there is no repayment obligation unlike debt. However, it also brings several challenges, such as ownership dilution, increased risk of hostile takeovers, and constant performance pressure due to public scrutiny. Regulatory compliance costs can be high, and market volatility can impact company valuation. Furthermore, shareholders may expect regular dividends, which can divert funds from reinvestment.

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5 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Susie Cook, FCPA

Group Treasurer | Change Agent | Corporate Finance | Risk Management | Financial Reporting | Mergers & Acquisitions
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To address challenges with common stock, implement staggered board elections to protect against takeovers and consider stock buyback programs to stabilize stock prices and show confidence in the company’s future. Regular updates and transparent communication with shareholders can align interests and mitigate agency problems. You can also structure common stock into different classes, such as Class A with more voting power and Class B focused on financial returns. This approach attracts diverse investor profiles, enhancing capital-raising efforts. Leveraging market intelligence and trend analysis helps time the issuance to maximize capital raised and minimize dilution, ensuring favorable conditions for the company and shareholders.

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What are the pros and cons of issuing preferred stock versus common stock?

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1 What is preferred stock?

2 What is common stock?

3 Pros and cons of issuing preferred stock

4 Pros and cons of issuing common stock

5 Here’s what else to consider

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