Participating Preferred Stock

Participating preferred stock is a class of preferred equity that combines a fixed preferred dividend with the right to share in additional dividends or liquidation proceeds alongside common shareholders. It ranks above common stock but below debt in a company’s capital structure.

Key takeaways

• Holders receive a fixed preferred dividend plus potential additional dividends when common dividends exceed a specified threshold.
• In liquidation, holders typically receive their liquidation preference (often the original purchase price) and may also share in remaining proceeds on a pro rata basis with common shareholders.
• Participating preferred is less common than nonparticipating preferred but can be used strategically (for example, as part of anti-takeover defenses).
• Compared with nonparticipating preferred, participating preferred offers greater upside but may dilute common shareholders’ residual claims.

How it works

Dividends
* Preferred shareholders receive a stated fixed dividend first.
* If the charter specifies a participation feature, preferred shareholders also receive additional dividends when common shareholders receive dividends above a set per-share level. The extra amount is usually the difference between the common dividend per share and the preferred dividend per share (or a proportional share of excess dividends).

Liquidation preference
* In a liquidation event, participating preferred shareholders are generally paid their liquidation preference (often their original investment or a stated value) before common shareholders receive anything.
After that payment, participating preferred holders may partake in the remaining proceeds alongside common shareholders according to a predetermined formula (for example, pro rata based on ownership percentage or conversion terms).
Nonparticipating preferred shareholders receive only their liquidation preference and do not share in remaining proceeds.

Examples

Dividend example:
* Preferred dividend = $1.00 per share.
Common dividend = $1.05 per share.
Participating preferred shareholders receive $1.00 + ($1.05 − $1.00) = $1.05 per share.

Liquidation example:
* Company has $10 million in participating preferred (20% of equity) and $40 million in common (80% of equity). Total proceeds on liquidation: $60 million.
Participating preferred first receives its $10 million liquidation preference. Remaining proceeds = $60M − $10M = $50M.
Participating preferred gets 20% of the remaining $50M = $10M, so total to participating preferred = $20M. Nonparticipating preferred would receive only its $10M preference.

Strategic uses

• Investor protection: Gives preferred investors upside participation while preserving priority claims.
• Anti-takeover mechanisms: Participating features can be part of defense strategies (e.g., “poison pill”) by making takeover outcomes less attractive to acquirers.
• Venture/PE financing: Used in negotiated investment terms to balance investor return and downside protection.

Pros and cons

Pros
* Potential for higher total returns than nonparticipating preferred.
Priority over common stock for dividends and liquidation proceeds.
Provides downside protection plus upside participation.

Cons
* Reduces the residual value available to common shareholders.
Can complicate capital structure and deal negotiations.
Less common and may carry complex contractual terms.

Bottom line

Participating preferred stock offers a hybrid of fixed-income-like protection and equity-like upside. It gives preferred holders a liquidation preference and the opportunity to share in excess dividends or remaining liquidation proceeds, providing stronger protection than nonparticipating preferred but potentially diminishing returns for common shareholders. Use and prevalence depend on negotiated financing terms and the strategic goals of the company and its investors.