Non-Participating Preferred Stock

Updated on May 5, 2024
Article byPriya Choubey
Edited byPriya Choubey
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Non-Participating Preferred Stock?

Non-Participating Preferred Stock refers to shares entitling holders to a fixed dividend payment, as the stock certificate specifies. They generally do not participate in any distribution of liquidation proceeds beyond their fixed preference.

Non-Participating Preferred Stock

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A non-participating liquidation preference means that preferred shareholders receive only their liquidation preference amount and do not receive any additional proceeds from the liquidation event. However, if preferred stockholders find that their shares hold a higher per-share value than common shares, they can convert their preference shares into common stock. This conversion enables them to claim a proportionate share of the overall liquidation proceeds.

Key Takeaways

  • The non-participating preferred stocks refer to those preference shares that empower the investors to receive a fixed dividend payment at the rate mentioned in the stock certificate. 
  • Non-participating preference shareholders have the right to receive the liquidation payment before common stockholders. Still, they cannot participate in surplus profit sharing or distribution of liquidation proceeds.
  • Non-participating preferred stocks are generally considered to have a lower risk profile compared to common stocks. However, investors should still be aware of potential risks related to the company’s financial stability and dividend payments.
  • Some preference shares may be eligible for cumulative dividend payments for any previous arrears and may be convertible into common shares under specific conditions.

Non-Participating Preferred Stock Explained

Non-participating preferred stocks are convertible preference shares that make the holder eligible to consistently reap a fixed percentage of dividends. However, they are not liable to participate in the distribution of surplus profits of the business after that. The holders have the right to dividend payment before distributing dividends to the common shareholders. Further, these stocks can be changed to common shares after a certain period. Moreover, any due dividends on the non-participating preference shares are payable as cumulative dividends.

In case of business closure, the non-participating preference shareholders are prioritized for any outstanding dividend payments. Also, they can claim their investment or assets limited to their preferential shares’ par value before the common stockholders. Even the participating preference shareholders are paid after the settlement of the non-participating preference stockholders. However, they are entitled to any share in further liquidation proceeds if they claim the preferential liquidation payment.

Examples

Non-participating preferred stocks are a specific kind of preference share that limits the risk and returns of the investors. Let us understand its structure with the help of the following examples:

Example #1

Suppose ABC Corp. issues $5 million of non-participating preferred stocks at a 7% dividend rate payable annually. The holders receive the dividend payment at this fixed rate every year. After 5 years, the company gets liquidated at a valuation of $20 million, and the non-participating preference stockholders are entitled to receive $5 million before the distribution of $15 million liquidation proceeds among the common shareholders.

Example #2

Century Properties Group (CPG) Inc. successfully raised P2 billion through a follow-on offering of perpetual, cumulative, non-participating, non-voting, redeemable, non-convertible Series B Preferred Shares (CPGPB). The issuance received a favorable investor response, enabling CPG to set the dividend rate at 7.5432%. The China Bank Capital Corporation acted as the lead underwriter, sole issue manager, and book-runner.

CPG’s President and CEO expressed gratitude to investors, partners, and stakeholders for their support, emphasizing their confidence in CPG’s growth. The proceeds from the offering will bolster CPG’s financial management and facilitate its expansion efforts. The Philippine Stock Exchange approved the offering for up to P4 billion, with 40 million preferred shares offered at P100 per share. Initially planned at P5 billion, the offering was adjusted downward.

Advantages And Disadvantages

Non-participating preferred stock is a source of fixed dividends for investors; however, it doesn’t provide exceptional returns. Some of its other pros and cons are discussed below:

Advantages:

  • Limited Risk: Due to the preferential liquidation payment, the assets of non-participating preference stockholders are exposed to limited risk compared to common stockholders.
  • Tax Efficiency: Unlike other income streams, the dividend income received on these preference stocks is liable to certain tax benefits.
  • Liquidity: The holders of these preference shares have greater liquidity benefits during the market turmoil, like converting their holdings into common stocks.
  • Priority in Dividends: Such preference stockholders are liable to receive dividends before the common shareholders, entitling them to preferential rights.
  • Fixed Dividends: The holders receive a fixed percentage as dividends periodically, thus ensuring a steady and consistent flow of income.

Disadvantages:

  • No Voting Rights: Non-participating preference stockholders have no voting rights in the company like the common stockholders, thus abstaining them from influencing business decisions.
  • Limited Profit: Although these stockholders receive fixed dividends, their earning potential is limited since they have no rights to additional profit sharing in the company.
  • Interest Rate Risk: If the current market interest rates upsurge, then the market value of these preference shares falls, making it an unattractive investment opportunity.
  • Inflationary Risk: Also, in the long run, the fixed dividend income from the non-participating preferred shares may not be enough to beat the inflation rate, thus declining its purchasing power and value.

Non-Participating vs Participating Preferred Stock

Participating and non-participating preferred stocks are two different forms of investment opportunities based on their features and the participation of holders in decision-making. Some of these dissimilarities are as follows:

BasisNon-Participating Preferred StockParticipating Preferred Stock
DefinitionIt is a type of investment whereby the holders are eligible to receive a fixed rate of dividends without any share in the company’s additional profits.It is an investment opportunity that allows the preferred stockholders to receive a specific rate of dividends together with additional profit sharing in the business.
DividendsEntitled to a fixed percentage of dividend income along with an additional share in the company’s profitsLiable to a fixed percentage of dividend income
Dividend PriorityBefore common shareholders but after paying the non-participating preference stockholdersPrior to the common stockholders
Return on InvestmentHigher ROIComparatively low ROI
Profit SharingRight to additional profit sharing in the businessNo such gains
Liquidation PreferenceReceives initial investment prior to common stockholders and is liable to participate in the remaining liquidation proceeds.Although it acquires initial investment before the common stockholders, such stockholders cannot participate in the remaining liquidation proceeds.
Risk-takingHighLimited
Voting RightsRareNo
Suitable ForInvestors who aim for high returns and are ready to take higher riskRisk-averse investors seeking stable income
Market Value of StocksAffected by the company’s growth and performanceNot influenced much by the business performance

Frequently Asked Questions (FAQs)

What are the features of non-participating preferred stocks?

Given below are some of the prominent characteristics of non-participating preference shares:
1. Convertible to common stocks;
2. Doesn’t have voting rights;
3. Limited growth potential without any additional profit sharing beyond dividends;
4. Prioritized over common stocks for dividend payment;
5. May be entitled to cumulative dividends; and
6. Redeemable at a predetermined price.

When to use non-participating preferred stock?

The non-participating preference stocks are generally issued during the startup funding rounds or venture capital fundraising by businesses since they safeguard the investors’ assets or invested funds from being exposed to the unlimited risk involved in these companies. Also, it allows them to draw uniform and steady dividend income.

Moreover, the startup founders can acquire funding without losing control over their business since the non-participating preference shareholders lack voting rights in the company.

What is the importance of non-participating preferred stock?

Non-participating preferred stock offers investors a stable and predictable source of income through fixed dividend payments. This stability is particularly appealing to risk-averse investors seeking consistent returns. Additionally, non-participating preferred stockholders have priority in receiving dividends. Overall, the importance of non-participating preferred stock lies in its ability to offer investors stability, income, and priority in financial distributions.

This article has been a guide to what is Non-Participating Preferred Stock. We compare it with participating preferred stock, and explain its examples, & advantages. You may also find some useful articles here –

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