Participating in preferred stock, like other types of preferred stock, is a priority in a company's Capital structure above common stocks but is ranked behind debt in liquidation situations. The extra dividend paid to a preferred shareholder is typically set so that it is paid when they receive dividends common shareholders get is more than the amount of a specific share. In case of liquidation, participants in preferred shareholders may get the price they paid for the stock in addition to the pro-rata portion of any funds remaining that common shareholders will receive.

In the event of liquidation, the fact that the preferred stock of an investor is participating or not will determine whether the shareholder receives additional consideration in addition to the value of liquidation that the stock is valued at, as well as any dividends due to an investor. If an investor's preferred stock is participating, the investor has the right to any value left over after liquidation, just as if it was common stock.

Participating preferred stock is seldom given out; however, one method that can be used is poison pills. In this instance, it is the case that current shareholders are given shares, which allows them to purchase new shares of common stock at a discounted value in the case of an unwelcome takeover offer.

Example

Let's say that Company A issue shares of preferred stock that pay a dividend of $1 per share. They also come with an extra dividends clause for preferred stock that is part of the participating group, activated when the dividend of common shares is greater than that of preferred shares. If, during the present quarter, Company A announces that it will pay an amount in the amount of $1.05 per share of the common stock, participants in the preferred stock will receive the amount of $1.05 for each piece ($1.00 and 0.05) in addition.

Considering a liquidation, company A has $10 million of preferred participant stock, representing 20 percent of the company's capital structure. The remaining 20%, which is $40 million, comprises common shares. Company A liquidates, and the proceeds amount to $60 million. Participating preferred shareholders will receive $10 million, but additionally, they would receive 20 percent of the remaining proceeds, that is, $10 million in this scenario. Non-participating preferred shareholders will not receive any additional benefits.

Participating Preferred Stock in Practice

Participation preferred by venture capitalists and private equity companies usually uses stocks in real life. Private and venture capitalists equity firms assume the enormous risk when they invest. Participating in preferred stock is a way for private equity and venture capital firms to protect themselves from risk when they invest.

Some companies use preferred participation shares to achieve a better value. In general, the price of preferred stock is less than ordinary shares. Therefore, offering preferred shares is the best way to reduce the weighted average capital costs (WACC) to get a better value.

Additionally, the funds obtained through participation preferred stock could be the sole large financial aid available to a business, especially the young, such as a start-up. The funding from participation preferred stock may improve a business's bottom line, increase the research and development process, and improve operations.

Advantages and Disadvantages

Participation rights are expected to yield a profit in the future, and the preferred stock price may be high, which is an appealing feature for investors who own the shares. But, it also reduces the amount of money that could be distributed to those who own common stock, which is a factor that can reduce the price of the issuer's stock.

Additional Participation Features

Participating preferred stock agreements could or might not contain additional features. For instance, the holders of the shares could approve certain actions, for example, company sales or other assets. The shareholders could also be granted voting rights similar to those of common stock shareholders. Another option is if those shares have cumulative rights because dividends not paid are due before dividends are issued to holders of common stock.

Participating Preferred Stock vs. Non-Participating Preferred Stock

The distinction between participating preferred and non-participating stock is how the capital after liquidation preferences have been satisfied is dispersed. Participating preferred stockholders and non-participating preferred stockholders will receive liquidation preferences and are distributed to creditors before common stockholders.

But, once the liquidation preference has been satisfied for non-participating and participating preferred stockholders, and there is surplus capital, the preferred stockholders are treated as the common shares. They will share the remainder of their profits with the common stockholders based on the base of their ownership.