A common question our clients have been asking us lately is “What is the difference between Common and Preferred Stock?” It’s a great question, and we want to make sure all of our followers are comfortable with the definition of each type of stock and understand the key differences between them.
Our short answer:
Stock represents ownership in the corporation that is usually held by owners and investors called the stockholders. The purpose of issuing stock is to give a corporation the opportunity to raise additional capital. Depending on what type of stock you hold, your rights to participate in the company’s business decisions may vary. The two basic types of stock issued by a corporation are Common and Preferred Stock. The most common differences between the two are outlined below.
When you hear people talk about stocks, they are most commonly referring to Common Stock. Common Stock represents an equity interest in the company. In the event a corporation is liquidated, common stockholders are at the most risk since they are at the bottom of the repayment “food-chain” if liquidation occurs. This means that there may not be anything left for the common stockholders after creditors and preferred stockholders receive their share from the corporation’s sale of its assets. To offset their risky position, common stockholders are afforded certain rights. For example, they have the opportunity to vote on fundamental changes of a corporation such as potential mergers, selling of assets, or amendments to important documents. So, although common stockholders are last in line to get whatever is left of the company, they are usually active participants in the decisions of a corporation.
In addition to Common Stock, a corporation may also issue Preferred Stock. It is also referred to as Investor Stock since it is the type of stock usually favored by investors when investing in a corporation. Preferred Stock has two main differences that distinguish them from Common Stock. The first is a liquidation preference, which means that in the event the company decides to call it quits, preferred stockholders receive liquidation payment before common stockholders, but not before creditors. The second is the right to receive additional rights not granted to common stockholders. For example, some corporations may grant first refusal, anti-dilution and drag-along rights to preferred stockholders; the right to nominate or elect a certain number of directors; participation in receiving additional dividends; or even converting their preferred stock into common stock. These rights are often proposed as a way to entice potential investors to put down capital into the corporation. Keep in mind that these additional rights are usually negotiated and not guaranteed. However, even though preferred stockholders have stronger financial security, they are usually passive actors in the operations of a corporation.
The Bottom Line
What is best for your company is really dependent on your role and your goals. For instance, if you’re a founder, you most likely want Common Stock because that would give you voting rights in the company. If you’re an investor, it would make sense to want Preferred Stock because it may offer financial preferences and incentives.
If you still have questions regarding the difference between Common and Preferred Stocks, we recommend reaching out to an experienced corporate attorney for advice. At Benemerito Attorneys at Law, we offer free consultations and would love to help guide you toward the right decision for your business.
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This blog is for informative purposes only. This information does not constitute legal advice. You should consult with a licensed attorney that can advise you according to your particular circumstances.