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Preferred Stock

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What is Preferred Stock? 

Preferred stock is a class of ownership in a corporation that has a higher claim on assets and earnings than common stock. Preferred shareholders receive dividends before common shareholders and have priority in the event of liquidation, but they typically do not have voting rights.

How It Works:

  • Dividends: Preferred shareholders receive fixed dividends before any dividends are paid to common shareholders.
  • Priority: In case of liquidation, preferred shareholders are paid out before common shareholders.
  • Convertible: Some preferred stocks can be converted into a specified number of common shares.

Advantages: 

Preferred stock provides a steady income stream through fixed dividends, making it attractive to investors seeking lower-risk investments. The priority in asset distribution also adds a layer of security, especially during liquidation. Additionally, convertible preferred stock offers potential for capital appreciation if converted to common shares.

Disadvantages: 

The main disadvantage of preferred stock is the lack of voting rights, which means shareholders have less influence over corporate decisions. Furthermore, the fixed dividend may be less attractive if the company’s common stock performs exceptionally well, as common shareholders may receive higher returns in such scenarios.

Example: 

A real-world example is the preferred stock issued by Bank of America. During the financial crisis of 2008, Bank of America issued preferred stock to raise capital, offering fixed dividends to attract investors while providing the bank with necessary funds.

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Related Terms

Adjusted EBITDA

Adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a financial metric used to assess a company's operational performance. It modifies the standard EBITDA by excluding non-recurring, irregular, or non-cash expenses to provide a more accurate reflection of ongoing profitability.

Angel Investors

Angel investors are affluent individuals who provide capital to startups or early-stage companies in exchange for equity ownership or convertible debt. These investors often offer not only financial support but also valuable business expertise and mentorship.

Anti-Dilution Provision

An anti-dilution provision is a clause in an investment agreement that protects an investor from dilution of their ownership percentage in the event that new shares are issued at a price lower than the investor originally paid. It is commonly included in venture capital and private equity agreements.

Bootstrapping

Bootstrapping in business refers to starting and growing a company using personal finances or the company’s operating revenues, rather than relying on external funding or venture capital. Entrepreneurs use their own resources and reinvest profits from initial sales to fund further growth, emphasizing financial independence and careful cash flow management.

Bridge Loan

A bridge loan is a short-term loan used to meet immediate financing needs while waiting for more permanent funding. It serves as a temporary solution to bridge the gap between the need for funds and the availability of long-term financing.

Cap Table

A Cap Table, or Capitalization Table, is a detailed spreadsheet or document that outlines the equity ownership, types of shares, and ownership percentages of a company. It includes information on founders, investors, and employees, as well as the dilution of shares over time through various funding rounds and option grants.

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