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Pros and Cons of Issuing Common Shares vs Preferred Shares

Common shares, sometimes basic shares, are businesses’ most common equity. While common and preferred shares have voting rights and a stake in the company’s profits, the risk/reward profiles and other associated privileges are somewhat different.

Preferred shares are a common point of negotiation in the early stages of a venture capital investment. Common shares typically go to the company’s workers and founders during this time.

Why do venture capitalists favor one over the other? To know that, we must first learn the pros and cons of issuing shares of both types. 

Let’s understand them one by one in this article.

Preferred Shares Vs Common Shares – An overview

Shares of preferred stock are also a kind of equity in the issuing company. Like bonds, investors purchasing these shares receive a regular dividend payment. Preferred stockholders get dividend payments according to a predetermined schedule for the duration of their investment.

Preferred Shares provide investors with some stability in this regard. Preferred stockholders get dividends before common stockholders do.

Preferred stock buyers have no say in company management. That implies they can’t participate in shareholder meetings or vote on matters. A preferred stock shareholder, for instance, wouldn’t have any influence over the selection of the new board of Common stock is a kind of ownership in a corporation.

Unlike preferred shares, these shares do not have a predetermined dividend distribution schedule or amount. The board of directors determines the dividend distribution rate for common shares. If the business has been successful throughout the dividend distribution period, the investor’s dividend payment will reflect that.

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Issuing Common and Preferred Shares- An Example

Let’s take an example comparing the issuance of common shares and preferred shares for a company, StarTech Inc.

Issuing Common Shares

Common Shares Offering: StartTech Inc. decided to issue 100,000 common shares to the public at an offering price of $10 per share.

Total Capital Raised with Common Shares: To calculate the total capital raised through common shares:

Total Capital Raised = Number of Common Shares x Offering Price 

Total Capital Raised = 100,000 shares x $10/share = $1,000,000

StartTech Inc. raises $1,000,000 in capital by issuing 100,000 common shares.

Issuing Preferred Shares

Preferred Shares Offering: StartTech Inc. also decides to issue 50,000 preferred shares with a fixed annual dividend of 5% at a par value of $50 per share.

Total Capital Raised with Preferred Shares: To calculate the total capital raised through preferred shares:

Total Capital Raised = Number of Preferred Shares x Par Value x Annual Dividend Rate 

Total Capital Raised = 50,000 shares x $50/share x 5% = $125,000

StartTech Inc. raises $125,000 in capital by issuing 50,000 preferred shares with an annual dividend obligation of $2.50 per share ($50 x 5%).

Comparison

  • With common shares, StartTech Inc. raises $1,000,000 but does not have a fixed dividend obligation.
  • With preferred shares, StartTech Inc. raises $125,000 but has a fixed annual dividend obligation of $2.50 per preferred share.

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Types of Preferred Stock and Common Stock

The various preferred and common stock options available to investors are as follows:

Preferred stockCommon stock
CumulativeOrdinary
NoncumulativeSuper-voting
ConvertibleNon-voting
Participating
Non-participating
Callable

Pros and Cons of Issuing Common Shares

Issuing Common shares has several advantages to a participant. They are:

  • The power to vote in the election of directors and other significant business matters is a common perk of being a common shareholder. 
  • Also, If a firm’s stock price rises over time, common investors may see an increase in their investment. They stand to gain by purchasing cheap and selling high.
  • Additionally, Common shareholders can receive dividends from the corporation if and when the company has a positive net income. 
  • Although variable, dividends bring income. Common shares of publicly listed corporations are often simpler to acquire and sell on the open market because they are more liquid than preferred shares.

On the other hand, common shares can also bring in a few drawbacks like:

  • When it comes to dividends, common shareholders rank behind preferred shareholders. They won’t get dividends until after preferred stockholders do. 
  • Common shares are riskier investments than preferred ones since they are more sensitive to market movements. Share prices are notoriously unpredictable.
  • Shareholders in a public company may have less influence if wealthy institutional investors or company insiders own a disproportionate number of common shares, even though all shareholders can vote on major issues. 
  • If a company is unsuccessful or has to spend its earnings to expand, it may decide not to provide dividends to its common shareholders.

Pros and Cons of Preferred Shares

Let’s now look at the benefits preferred shares offer a company’s management.

  • When it comes to dividends, preferred shareholders rank ahead of common shareholders. Usually, they get dividends that are either fixed or adjustable, which gives them greater income stability.
  • Preferred stock is often less volatile than ordinary stock. They’re appealing to income-focused investors because of the security and possible revenue they provide.
  • Preferred shareholders have the right to get their investment back first in the case of a corporate collapse, ahead of regular shareholders.
  • Preferred shareholders do not often have voting rights, which might benefit management wanting to control the firm.

That brings us to understanding preferred shares’ drawbacks over the company and the employees. Here are a few.

  • Preferred stock often gains less from capital appreciation than common stock. The price is usually set in advance, and the buyer may not benefit completely from an increased stock price.
  • Without voting rights, shareholders have no influence in corporate affairs, which is a benefit for management but a disadvantage for investors.
  • Some preferred stocks are vulnerable to changes in interest rates. The current value of preferred shares may fall if interest rates increase.
  • Preferred stock owners may suffer if the company exercises its right to “call” or redeem the stock at a specified price, known as “call risk.”

The following table compares the advantages and disadvantages of common vs. preferred shares to facilitate an understanding of the features of this equity ownership.

AspectCommon SharesPreferred Shares
Ownership Rights and ControlVoting rights, allowing shareholders to participate in company decisions.Typically, no voting rights, providing less influence over corporate matters.
Dividend PriorityLower priority in receiving dividends. Common shareholders get paid after preferred shareholders.Higher priority in receiving dividends. Preferred shareholders often receive fixed or higher dividends before common shareholders.
Capital AppreciationPotential for significant capital appreciation, offering higher returns if the company’s stock price rises.Limited capital appreciation potential, as preferred share prices are often stable and do not increase significantly.
Dividend StabilityDividends can fluctuate and may not be guaranteed.Dividends are generally stable and predictable, providing a steady income stream.
Liquidation PreferenceCommon shareholders have a lower priority in receiving assets in case of company liquidation.Preferred shareholders have a higher claim on company assets in the event of liquidation, enhancing protection.
Risk and VolatilityCommon shares are more volatile and subject to market fluctuations.Preferred shares are less volatile and offer more stability.
Investor AttractionAttracts investors seeking potential capital gains and willing to accept higher risk.Attracts income-oriented investors seeking stable dividends and capital preservation.
Voting Rights and InfluenceAllows shareholders to vote on corporate matters and have a say in company decisions.Limited or no voting rights mean less influence over company affairs.
Callable by the CompanyTypically not callable by the company.May be callable by the company, potentially leading to the redemption of shares.
Conversion OptionsGenerally no conversion options for common shares.Some preferred shares may have conversion options, allowing them to be converted into common shares.
Tax TreatmentCommon share dividends may qualify for lower tax rates in some jurisdictions.Preferred share dividends may have tax advantages, depending on the jurisdiction and structure.

Striking the Right Chord: Common Shares vs. Preferred Shares

Common shares, which usually come with voting rights, are a suitable option for those who wish to have a say in the running of a firm. There is no voting representation for preferred shareholders.

Preferred shares, which pay low but stable dividends, can be the best option for those needing money quickly. If the share price rises, investment returns on common shares may be greater in the long run.

Keep in mind that not every stock is equal. Preferred shares offer varying rights to investors in various fundraising rounds. Investors in subsequent rounds may also seek renegotiation of anti-dilution protection and other benefits granted to investors in previous stages.

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