How to Choose to Issue Preferred Stock or Common Stock

Both preferred and common stock are ways in which companies raise capital from prospective investors. From the investor point of view, preferred and common stock provide two different risk/return profiles. From the issuing company's perspective, preferred stock acts a lot like equity---the principal is not guaranteed and the interest payments are treated as dividends. Preferred stock holders are also paid before common stockholders. The challenge for the issuing company is determining which capital-raising instrument is best for it.

Instructions

1. Choose preferred stock if you want to issue stock without the right to vote. Preferred stockholders give up this right, since they are paid prior to common stockholders.

2. Choose preferred stock for a higher earnings per share. Preferred stock does not require the issuance of additional shares of stock. Therefore, it does not have the same dilutive effect that raising additional capital through a common stock issuance would have.

3. Choose preferred stock if you want to lower the debt-to-equity ratio for a better risk profile. Preferred debt means the company can raise capital, but not have to worry about increasing long-term debt numbers.

4. Issue preferred stock if you're concerned about a takeover bid. Preferred stock is a good way to raise capital without giving away controlling interest in the stock. Preferred stock can also be structured to gain value after a hostile takeover.

5. Issue common stock if your problem is one of liquidity. Preferred stock will obligate you to make cash payments in the form of dividends.

References

• Preferred Stock
• Differences Between Common and Preferred Stock