Difference Between Common Stock and Preferred Stock

July 11, 2021 by Soject

The offering of preferred stock entails certain tax breaks for companies. For this reason, company managers are usually eager to offer this type of stock and attract preferred shareholders. In this article, SOJECT compares ordinary and preferred stocks and examines the characteristics of each. But first of all, we have to see what stocks are.

Share Definition

According to related legal authorities, the share is a part of the capital of a joint-stock company, which indicates the amount of participation, obligations, and interests of its owner in the joint-stock company.

The share may be anonymous or anonymous. However, shares are called preferred stock if they are given a dividend. The total value of the shares is equal to the company capital. The owner of each share is allowed to take any action on his share of stock.

What Is Common Stock?

Common stock is a document that indicates a certain percentage of the company’s capital belongs to certain people to enjoy the company’s profits and benefits. Ordinary shareholders are the main owners of the company and hold the following rights and benefits:

• The right to receive dividends;
• The right to vote in ordinary general assemblies and extraordinary assemblies;
• Pre-emptive right to purchase new shares;
• The remaining assets right after the liquidation of the company;
• The right to be informed about the activities of the company.

Ordinary shares are the shares that companies usually offer, and shareholders own the company in proportion to their shares.

What Are Preferred Stocks?

Preferred stock or Preferred share refers to a stock that has special privileges compared to ordinary shares. Each joint-stock company can arrange preferred shares based on the articles of association and the approval of the extraordinary general assembly of shareholders. The benefits of such stocks and how to use them must be clearly defined.

The Extraordinary General Assembly must approve any change in the privileges related to the company’s preferred shares with the consent of the holders of half plus one. Preferred stock is a transferable certificate of ownership that gives the holder a limited and fixed right to the company’s assets.

What Privileges Should Be Mentioned for Preferred Shares?

These types of privileges that must be mentioned in the company’s articles of association and approved by the Extraordinary General Assembly of shareholders are:

1- Applying a discount on the payment of the nominal value of shares

2- Allocating more profits to preferred shares

3- Payment of the nominal value of shares to the holders of the preferred shares before the company’s liquidation (when the subject of liquidation is raised.)

4- Applying opinions regarding the appointment of company managers or the superiority of the votes of preferred shareholders over ordinary shareholders

5- Excluding preferred shareholders from performance losses

The principle is that all stocks are the same. However, there is an exception in the law, according to which preferred shareholders enjoy certain privileges. By reviewing the preferred stock definition, you will find out this type of stock only exists in joint-stock companies. Through these shares, the owner can enjoy benefits such as having more voting rights, prioritizing dividends, becoming a board member, etc.

Preferred Stock Benefits

Individuals who have preferred shares in a company can benefit from two types of points: financial points and non-financial points.

Financial ratings

1- A certain percentage of the company’s profit belongs to privileged partners.

2- If the company makes no profit, it owes a certain amount to the privileged partners.

3. Dividends on this type of stock are paid before ordinary dividends.

4- Preferential partners have the right of precedence over other partners in terms of trading with the company.

5. Preferential shareholders also have priority to the right to purchase new shares from the company.

6. At the time of company liquidation, the salaries of the preferred shareholders are paid first.

Non-Financial Ratings:

1- Sometimes, additional voting rights are considered for the owners of the preferred shares.

2. However, sometimes, some qualitative points are assigned to the vote. For example, a company may make decisions about a particular issue based on the votes of its preferred shareholders.

3. The company may grant privileges to preferred partners to be elected for as  the board members

Preferred Stock Features

One of the characteristics of preferred stock is it’s cumulative. 

In times of crisis, companies usually suspend the payment of the annual dividend to shareholders. However, if the company has lost for two consecutive years, at the end of the third year while paying dividends, it must first pay the preferred shareholders for the past two years. As mentioned, this feature is called cumulative.

Furthermore, when the company is liquidated, the preferred shareholders are preferable to the ordinary shareholders. However, you should note that any interest to the shareholders is made after paying the companies debts.

Preferred Shares in Startups

When it comes to startups, there is always someone who has come up with the initial idea. But most of the time, there is a significant obstacle: capital!  In other words, the founder needs money to launch the new business. That’s why startups look to raise capital via investors. The issuance of preferred stock can play a crucial role in raising capital. In fact, it encourages investors to finance. 

Learn more: What Is a Convertible Note?

The investor benefits by providing the capital needed by the startup and receiving preferred shares in return. For this reason, the shareholder accepts the financing risk to obtain the expected profit in the future as well as playing a role in the management of the company.

What Is the Difference Between Ordinary and Preferred Stocks In Summary?

1- Priority of receiving dividends by preferred shareholders.

2. At the time of the company liquidation, ordinary shareholders will not receive any money until the preferred shareholders receive their payment.

3- Preferred stock dividends are different from ordinary stocks as they are usually larger.

5. Preferred stock dividends are usually guaranteed. For example, suppose the company does not pay dividends for one year. In that case, at the end of the second year, it must first pay dividends of preferred stockholders for the two past years and then pay the ordinary shareholders for one year.