What are the pros and cons of issuing preferred stock versus common stock? (2024)

FAQs

What are the pros and cons of issuing preferred stock versus common stock? ›

Common stock has higher long-term growth potential than preferred stock but also has lower priority for dividends and a payout in the event of a liquidation. Lenders, suppliers and preferred shareholders are all in line for a payout ahead of common stockholders.

Is Preferred or Common Stock a Better Investment? Each type has pros and cons. Common stock tends to offer higher potential returns, but more volatility. Preferred stock may be less volatile but have a lower potential for returns.

Among the downsides of preferred shares, unlike common stockholders, preferred stockholders typically have no voting rights. And although preferred stocks offer greater price stability – a bond-like feature – they don't have a claim on residual profits.

3 Pros and cons of issuing preferred stock

For your company, preferred stock can improve your credit rating and reduce your cost of debt, as preferred stock is less risky than common stock for lenders. Preferred stock can also help you retain control of your company, as preferred stockholders do not have voting rights.

Advantages of issuing common stock:

This investment brings higher returns through capital gains and dividends anytime the company's stock valuation rises. On the other hand, dividends arise when the company remains with substantial revenue after clearing its commitments.

Broadly speaking, preferred stock is less risky than common stock because payments of interest or dividends on preferred stock are required to be paid before any payments to common shareholders. This means that preferred stock is senior to common stock.

1. Preferreds are issued with a fixed par value and pay dividends based on a percentage of that par, usually at a fixed rate. Just like bonds, which also make fixed payments, the market value of preferred shares is sensitive to changes in interest rates. If interest rates rise, the value of the preferred shares falls.

Issuance of preferred stocks will result in a higher risk, to the disadvantage of common stockholders. The preferred stockholders have superior voting rights in the selection of board of directors. There is a seniority of preferred stockholder's claim over common stockholders.

Who benefits the most from preferred stocks? ›

Preferred shares can offer an avenue for income investors wanting more yield than either corporate or government bonds. At the same time, these shares allow people to buy into an investment that offers a bit more safety than common stock. Yields are subject to change with economic conditions.

Some of the main advantages of preferred stock include: Higher dividends. In general, you can receive higher regular dividends with preferred shares. Payouts are also usually greater than what you'd receive with a bond because you're assuming more risk.

Owners of preference shares do not have normal voting rights. That allows a company to issue preferred stock without upsetting controlling balances in the corporate structure. Common stock provides a degree of voting rights to shareholders, allowing them an opportunity to impact crucial managerial decisions.

Issuing stock as a source of long-term financing offers advantages such as increased capital, no repayment obligation, and limited liability. However, it also has disadvantages including loss of control, dividend expectations, and reporting requirements.

Investors with common stocks own voting rights without any stress of company legalities. However, the profitability of most common stocks is limited because they are prioritized in payouts and the company's freedom to defer dividends until funds are largely available.

Issuing preferred stock provides a company with a means of obtaining capital without increasing the company's overall level of outstanding debt. This helps keep the company's debt-to-equity (D/E) ratio, an important leverage measure for investors and analysts, at a lower, more attractive level.

Convertible preferred shares give their holders the option of converting them into a set amount of common stock shares in the future. This gives the shareholder the potential benefit of capital appreciation in addition to the guaranteed benefit of a regular dividend.