Key Takeaways

  • A preferred stock certificate represents a shareholder’s claim to ownership in a corporation and often provides fixed dividends and priority rights.
  • A stock certificate, whether for common or preferred shares, serves as a certificate of ownership in a corporation; common or preferred, listing share class, par value, and restrictions.
  • Common stockholders typically have voting rights and benefit from long-term growth, while preferred stockholders receive priority dividends and liquidation preference.
  • Institutions are the primary buyers of preferred stock due to favorable tax treatment, though individual investors may use it for steady income.
  • Preferred shares can be structured in many forms—convertible, callable, or cumulative—depending on the company’s financing strategy.

A preferred stock certificate is a document that identifies the ownership share of an investor in a corporation.

What Is a Preferred Stock?

A preferred stock is a form of ownership in a corporation which yields higher earnings than common stock, and it also holds a higher claim on the corporation's assets. Shares of preferred stock do not generally carry with them voting rights.

Additionally, holders of preferred shares are usually given a dividend that is paid out first before any dividends that may be paid out to common shareholders. These dividends paid to holders of preferred stock are typically higher than those that are paid to shareholders of common stock. These dividends may be paid either monthly or quarterly. Preferred stock not only pays fixed dividends, but it also gives the owner some equity, as the preferred stock has the potential for price appreciation.

Types of Preferred Stock

Corporations may issue different classes of preferred shares to meet specific investor or financing needs. Common variations include:

  • Cumulative Preferred Stock: Requires unpaid dividends to be carried forward and paid to preferred holders before common shareholders.
  • Non-Cumulative Preferred Stock: Does not guarantee missed dividend payments in future periods.
  • Convertible Preferred Stock: Allows investors to exchange preferred shares for a set number of common shares, offering potential upside.
  • Callable Preferred Stock: Gives the issuing corporation the right to repurchase shares after a certain date at a predetermined price.
  • Participating Preferred Stock: Provides the right to receive additional dividends beyond the fixed rate if the company performs well.

These variations highlight why preferred shares appeal to investors seeking both income and certain contractual rights that differ from common stock.

What Is a Stock Certificate?

A stock certificate is a generated document that makes known what an investor's ownership share is in a corporation. A stock certificate generally includes the following information:

  • The number of shares
  • Par value of the shares (if there is any par value)
  • An identification number of the certificate
  • The signatures of all authorized corporate executives
  • The class of shares (whether they are preferred stock or common stock)

Stock certificates are hard to fraudulently replicate because they contain complex etchings and designs. The documents are generally kept away in storage and the electronic versions of the certificates are traded. For that reason, it is uncommon for investors in publicly held companies to actually view the underlying stock certificates.

There may be trading restrictions noted on either the face of the stock certificate or the back of the certificate. A shareholder may sell the stock certificate only if there is no restriction on the certificate stating that the certificate cannot be sold.

Legal Importance of Stock Certificates

A stock certificate is more than just a record of ownership; it can serve as legal evidence in disputes over share ownership. Courts often rely on properly executed certificates when determining the rights of shareholders.

Modern corporations frequently issue electronic certificates through transfer agents, but the essential role remains the same: to confirm a shareholder’s proportionate claim to assets, dividends, and, in the case of common shares, voting rights. Whether the certificate is for common or preferred shares, it is a recognized certificate of ownership in a corporation; common or preferred under corporate law.

In closely held corporations or startups, certificates often play a critical role in investor agreements, ensuring compliance with negotiated terms such as liquidation preferences or transfer restrictions.

What Is the Difference Between Preferred Stock and Common Stock?

Common stock is—by law—prescribed, and every share of common stock brings with it one shareholder vote. In the event dividends are declared, shareholders of common stock are entitled to common stock dividends at a prorated share.

Under Delaware law, there is no set formula or prescription for preferred stock. The terms of preferred stock are open and are only limited by negotiations done by the Board of Directors. Preferred stock can either be voting stock or it may be non-voting stock. Depending on the goals of the company, preferred stock may be structured in order to offer the investors financial assurances without allowing the shareholders to have voting rights.

Preferred stock and common stock may be used by a company at the same time. Therefore, they are not mutually exclusive. A company may choose to use preferred stock along with common stock in order to preserve insider voting control while it is in working to raise investment capital, for example.

Advantages and Disadvantages for Investors

Advantages of Common Stock:

  • Voting rights that allow shareholders to influence corporate governance.
  • Potential for significant long-term appreciation if the company grows.
  • Residual claim on profits after preferred dividends are paid.

Disadvantages of Common Stock:

  • Dividends are not guaranteed and are paid only after preferred dividends.
  • Greater risk of loss in the event of liquidation.

Advantages of Preferred Stock:

  • Fixed dividends that are paid before common shareholders receive any.
  • Priority over common stock in the event of bankruptcy or liquidation.
  • Some preferred shares offer features such as convertibility or cumulative dividends.

Disadvantages of Preferred Stock:

  • Limited or no voting rights.
  • Lower potential for capital appreciation compared to common shares.
  • Callable features may limit long-term investment gains.

This balance between rights and risks is why corporations often issue both types, tailoring financing to different classes of investors.

Standard Buyers of Preferred Stock

Preferred stock is available in a vast variety of different forms. A company has the ability to issue preferred shares under nearly any set of terms they come up with, as long as these terms are not contrary to laws or regulations. Most preferred issues do not have maturity dates, or if they do, the dates are quite far into the future.

The most common buyers of preferred shares are institutions, due to tax advantages that the institutions have available to them that are not also available to individual investors. As institutions typically make these purchases in bulk, preferred issues tend to be a simple way to raise significant amounts of capital. This is the reasoning behind the fact that private and pre-public companies tend to issue preferred stock.

The issuers of preferred stock have a tendency to group near both the lower and upper limits of the credit-worthiness spectrum. Some companies choose to issue preferred shares since certain regulations may prohibit them from incurring any additional debt, or these companies may decide to issue preferred shares to try and avoid being downgraded. Although preferred stock is considered equity, it is comparable in many ways to a bond issue. Some forms can act as a debt when considered from a tax perspective, such as a trust preferred stock.

Strategic Uses of Preferred Stock by Corporations

Companies issue preferred stock for a variety of strategic reasons:

  • Capital Raising Without Diluting Control: By offering preferred shares with limited or no voting rights, corporations can raise funds while keeping control in the hands of common shareholders.
  • Debt Alternative: Preferred stock is considered equity but can be structured to mimic debt, appealing to companies constrained by debt covenants.
  • Investor Attraction: Features such as convertibility and high dividend yields make preferred stock attractive to venture capitalists or institutional investors.
  • Tax Efficiency: In certain jurisdictions, dividends paid on preferred stock may be deductible or taxed at a lower rate, enhancing its appeal to institutions.

Frequently Asked Questions

  1. What is the main difference between common and preferred stock certificates?
    Common stock certificates provide voting rights and growth potential, while preferred certificates emphasize fixed dividends and priority in liquidation.
  2. Do companies still issue physical stock certificates?
    Most corporations now issue electronic certificates, though some private companies may still provide paper certificates as legal proof of ownership.
  3. Why would a company issue preferred stock instead of debt?
    Preferred stock allows companies to raise capital without increasing debt obligations, while still offering investors predictable income.
  4. Can preferred shares be converted into common stock?
    Yes, some preferred shares are convertible, allowing holders to exchange them for common shares at predetermined ratios.
  5. Who typically buys preferred stock?
    Institutional investors, such as insurance companies and banks, are the primary buyers due to favorable tax treatment and steady dividend income.

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