Common Stock vs Preferred Stock

Two of the most common types of stocks are common stock and preferred stock. This article will delve into the characteristics of common stock, its various types, and compare it to preferred stock, highlighting their key differences.

Common Stock

Common stock is the most basic and widely held type of stock in a company. By purchasing common stock, you acquire a proprietary stake in the business, giving you the right to vote on pivotal matters such as electing the board of directors and adopting company policies. This ownership comes with a degree of risk, as the value of your investment is directly tied to the company's earnings and overall success.

Types of Common Stock

• Voting Stock: This type of common stock confers voting rights, allowing shareholders to participate in important company decisions. Voting stock is typically the most common type and offers the most significant influence over the company's operations.
• Non-Voting Stock: Some companies issue non-voting stock, which does not grant shareholders the right to vote. This type of stock is often used by companies to raise capital without diluting the control of existing shareholders.

Preferred Stock

Preferred stock is a unique type of stock that offers more stability and protection compared to common stock. It is often used by companies to balance the interests of investors and founders, particularly in private equity (PE) and venture capital (VC) deals. Preferred stockholders receive preferential treatment, particularly in liquidation events and dividend payouts.

Characteristics of Preferred Stock

• Dividends: Preferred shareholders typically receive a fixed dividend, which can be cumulative or non-cumulative. In cumulative structures, missed dividend payments accumulate and must be paid out before common shareholders receive any dividends. Non-cumulative arrangements mean that if a dividend is skipped, it is not owed in the future.
• Liquidation Preferences: The liquidation preference governs the order in which investors are paid in the event of a liquidation, acquisition, or other exit scenarios. Preferred stockholders often enjoy the right to receive their investment back before common stockholders get any residual value. Liquidation preferences can be structured as senior, pari passu, or junior, with different payout scenarios.
• Voting Rights: Unlike common stock, preferred stock often comes with limited or no voting rights. This means that preferred shareholders do not have a significant say in major company decisions unless they own voting preferred stock.

Comparison of Common Stock and Preferred Stock

Risk vs. Stability

- Common Stock: The value of common stock is directly tied to the company's earnings and overall success. This means that common stockholders face higher risk as their investment value can fluctuate significantly based on company performance.

- Preferred Stock: Preferred stock offers more stability and protection. Investors receive a fixed dividend and have priority in receiving payments before common shareholders in the event of a liquidation or distribution of profits. This makes preferred stock a more stable investment option, particularly for those seeking predictable income.

Ownership and Control

- Common Stock: Common stockholders have voting rights, allowing them to influence company decisions and participate in the governance of the business. This gives them a sense of ownership and control over the company.

- Preferred Stock: Preferred stockholders typically do not have voting rights, which means they have less control over company decisions. However, they receive preferential treatment in terms of dividend payments and liquidation preferences, ensuring their financial interests are protected.

Investment Goals

- Common Stock: Common stock is ideal for investors who are willing to take on higher risk in pursuit of potential long-term capital appreciation. It offers the potential for significant returns if the company grows and performs well.

- Preferred Stock: Preferred stock is more suited for investors seeking stable financial benefits and low risk. It provides a fixed dividend and ensures priority in receiving payments, making it an attractive option for those seeking predictable income.

Conclusion

Common stock and preferred stock serve different purposes and offer distinct benefits to investors. Common stock provides ownership and voting rights, making it suitable for those willing to take on higher risk in pursuit of potential long-term gains. Preferred stock, on the other hand, offers stability and protection with fixed dividends and priority in payments, making it ideal for investors seeking predictable income and low risk.