Convertible Preferred Stock

by Foti Panagiotakopoulos Founder at GrowthMentor

Table of Contents

Definition of Convertible Preferred Stock

Convertible preferred stock is a type of share that comes with an inbuilt provision that gives the owner the option to convert them into a predetermined number of common shares after a specific date. The value of convertible preferred stock is based upon the performance of common stock.

As a form of hybrid security, convertible preferred stock is notable for having elements of both debt and equity. Their market price typically rises and falls alongside the share price for common shares, and the shares themselves are often held by venture capitalists.

Preferred stock can be broken into multiple different types, with the most common including callable preferred, cumulative preferred, participating preferred and, of course, convertible preferred, which is what we’re taking a look at here.

In the vast majority of cases, preferred stock is only exchanged due to a request from the shareholder. However, provisions are occasionally included which allow the company or the stock’s issuer to force the exchange of convertible preferred stock.

One of the most common reasons for people converting their stock is that the common shares are trading above the conversion price. This essentially allows them to convert their stock and to automatically receive a higher value.

Convertible preferred stock holders are able to make their conversion at any time, and they’re under no obligation to actually do so. Most preferred stockholders choose to convert their stock either when the company goes through an IPO (initial public offering) or when they’re acquired by someone else.

What is par value?

Par value is a value that’s assigned to preferred stock and which determines how much money the stock holder is entitled to receive if the company goes bankrupt.

What is a conversion premium?

Conversion premium is the term that’s used to refer to the difference between the value of their preferred shares and the value that they’ll be at if they’re converted.

Are preferred shares debt or equity?

Preferred shares are somewhere between debt and equity, bringing together aspects of both of them. They give owners a fixed dividend, but they also provide the right to claim assets if a company liquidates at a rate that’s determined by the par value. However, preferred shareholders don’t have the same voting rights as regular shareholders.

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