Common stocks and preferred stocks 101

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When a business is incorporated, there are different classes of stock that come into being. At the very onset of a corporate’s journey, common stocks are created. Simply put, these are default stocks that exist from the very moment of incorporation till other classes of stocks such as preferred stocks are created. 

Owning common stocks typically translates into having certain rights that can be exercised within the organisation. 

So common shareholders can vote on matters concerning the business and board members alike based on the percentage of common shares they have to their name. For instance, let’s say an individual owns 10% of common shares in the company, he/she can cast 10% of vote in corporate meetings. How can you access common stocks? These are stocks that are ‘commonly’ traded in stock markets. And while these might not be dividend yielding stocks, holding them over a long-period of time may lead to long-term wealth creation. 

Another class of stocks to dominate the share capital space are preferred stocks. These equity instruments rank higher than common shares in the stock class hierarchy. 

Preferred stocks are issued by a company as a fund-raising exercise with its price determined by market forces and the company’s performance. At the time of issue, investors are made aware of a predetermined maturity period, rate of dividend, and a set dividend payment date.  

As the name suggested, these stocks are given a higher ‘preference’ when it comes to dividends and liquidation. Preferred shareholders receive dividends before common shareholders. And should a company declare bankruptcy, preferred shareholders are entitled to be paid from the company’s assets before common shareholders. 

While both, common and preferred stocks represent ownership in a company and both serve as tools for investors to make profits from a business’ future success, there remains one fundamental difference between these two kinds of stocks. 

Common stockholders have a voting right depending on the number of stocks they own in proportion to the total number of shares the company has issued. On the other hand, preferred stockholders do not have any voting rights in the company. 

There are 4 different kinds of preferred shares with varying features and benefits. 

The first is known as cumulative preference shares. Such shares allow the issuing company to pay dividend in arrears in the next year in case its financial status does not allow the company to shell out dividends in the current year. 

The next category of preferred share are callable shares. In this case the issuing company can buy back the stocks at a fixed price on a future date. The benefits of the company far surpass the benefits of the shareholder as the company is able to place a favourable cap on the stock’s value. 

There are also preferred shares that can be exchanged for common shares at a fixed rate — these are known as convertible shares. This can be especially profitable for preferred shareholders if the common share is highly valued in the market. 

Last on the list are participatory preference shares that come with fixed dividend rates. There may also be additional dividends in case the issuing company meets certain financial goals — in certain scenarios this could be very well over fixed dividend rates. 

So what are better, common stocks or preferred stocks? 

There is no definitive answer, as this entirely depends on the investor’s goal. Common stocks have the tendency to be more profitable than preferred shares and bonds with a huge potential for long-term gains depending on how the company performs. However if things don’t go according to plan, liquidation of preference stocks are prioritised. 

If you have a company and are looking to liquidate common stocks that are in the form of Employee Stock Options, reach out to Unlistedkart. We can help you liquidate vested ESOPs by bringing you onboard our vast network.