Once a start-up business manages to attain a sustainable and a substantial size in the market, it looks at securing funds for further expansion of the business by means of issuing either of these two types of stocks: Common Stocks and Preferred Stocks. Both the types of stocks grant ownership of the company to the stockholder however they differ from each other on the following three parameters: privileges granted to the stockholder, the restrictions imposed upon the stockholder and the benefits passed on to the stock holder.
Common stock is the most popular and widely purchased stock that people usually refer to when they talk about buying shares or stocks of a company. A common stock grants share in the ownership of the business. As an owner a common stock holder enjoys certain privileges that are available to an owner like voting authority/rights in business impacting decisions like mergers and acquisitions etc. Predominantly, a common stock holder enjoys a share in profits of the business as well. These profits are distributed in the form of dividends. Another benefit that a common stock holder enjoys is the rise in the prices of the company’s stock. In the event a company or business gets liquidated and fails to remain afloat, a stock holder has the last claims on the remaining or residual assets, which is left after paying off the dues to the creditors and the preferred stock holders. As seen historically and practically, in cases of bankruptcy, a common stock holder almost gets nothing paid back to him.
A preferred stock holder, as the name suggests, enjoys certain preferences or privileges as compared to a common stock holder. They enjoy fairly stable and assured dividend payout as and when the company makes profits and decides to pay out dividends. These shareholders enjoy the benefits when the company is in trouble and has problems while paying dividends as the preferred stock holding assures the payout of the committed amount. However, when the dividend payout rises, then these stock holders miss out on the incremental profit as they get only fixed returns. The return on investment in a preferred stock is usually higher than investing in common dividends or company’s bonds.
The dividend payout to the preferred stockholders happen before the payout to the common stockholders, thus one can say that owners of preferred stock enjoy payment priority. A company is obligated to payout unpaid preferred dividends before the common stock holders receive a single penny. In case the company files for bankruptcy and the assets have to be liquidated, then the preferred stockholders receive any money left over before the common stockholders.
While the preferred stock holders enjoys a greater security, the returns on the investments are lesser than that of a common stock holder. If a company makes profits and increases the dividend payout a preferred stock holder would not be entitled to the increased payout. In this sense a common stock holder would be able to benefit from the increased payout, at the risk of not earning any dividends while the company is underperforming.
The preferred stockholders also do not enjoy the benefits associated with the appreciation in the share price as a common stock holder does. As the dividends are fixed for preferred shares, the price of the share or stock in such a case is determined by the yield they offer. In this sense preferred share are more like the bonds or debt instruments of a company.
Unlike the Common stockholders, the preferred stockholders do not enjoy voting rights, hence they cannot participate in any business impacting decision of the company.
Thus the decision to invest in common stocks or preferred stock depends on the amount of risk a person is willing to take. As is evident from the definitions presented, common stock holders enjoys greater benefits when a company turns profitable. But they also stand to lose their entire investment if the company becomes bankrupt.