Did you know that the method of fundraising matters a lot?

I am not talking about the methods - Equity, Debentures, and Convertibles.

That's probably basic knowledge for some of you now!

Right now, I am talking about different sub-types in preferred shares.

Why?

Because it’s the investor’s most preferred choice of investment instrument.

Preferred Shares allow the investors to have a certain degree of safeguard with their investments.

They offer the investors superior claim rights compared to common equity shares in two ways:

(a) Dividend declaration:

When the company declares dividends, they would get paid first before the common equity holders.

(b) Liquidation proceedings:

In the case of the sale, acquisition, or winding up of the company, they are paid their investment amount.

Or in some cases, they get additional amounts as well from the proceeds of the event.

Now, there are a number of preferred shares.

It all depends on the rights associated with them.

Let's find these out.

Some Terms You Need To Know:

(1) Convertible Shares vs. Non-Convertible:

Convertible Shares: These can be turned into common shares after a specific period at a fixed rate.

For example, a 1:1 ratio means one preference share can become one equity share.

Non-Convertible Shares: They're more like a debt and can't be converted into common equity.

(2) Cumulative and Non-Cumulative:

As you know, there is a fixed dividend attached to preference shares.

Cumulative Preference Shares: If the company doesn't make a profit in a certain year, the dividend owed to these shareholders accumulates and is carried forward to the next year.

Non-Cumulative Preference Shares: If the company doesn't make a profit in a year, these shareholders lose their right to a dividend for that year.

(3) Participating Shares:

One advantage of being a common equity shareholder is the dividend they get varies based on the company's profits each year.

However, preferred shareholders usually receive a fixed rate.

But in the case of participating preference shares, they get the fixed rate and a share of the extra profits when common shareholders earn more.

The same goes for liquidation events like sales or acquisitions.

Participating preference shareholders have a right to a slice of the surplus profit, which is typically only for common shareholders.

That's it!

I hope you got to understand the different types of preferred shares.

And why they are important to begin with.

Moving forward, use this knowledge to negotiate your funding rounds! :)