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Corporations • Rights of Shareholders
CORP#054
Legal Definition
Owners of common stock get paid last and equally.
Owners of preferred stock get paid in full first.
Owners of preferred stock that is participating get paid twice—as preferred shareholders and as owners of common stock.
Owners of preferred stock that is cumulative have a right to payment for prior years in which dividends were not paid, as well as payment for the current year.
Owners of preferred stock get paid in full first.
Owners of preferred stock that is participating get paid twice—as preferred shareholders and as owners of common stock.
Owners of preferred stock that is cumulative have a right to payment for prior years in which dividends were not paid, as well as payment for the current year.
Plain English Explanation
In other cards, for the sake of simplicity, we've discussed shareholders as if all shares of stock are equal. Technically, this is not true and sometimes you'll need to be aware of the specific types of stock in order to answer a question. One of the most common times you'll need to know the difference between types of stock is when it comes to distributions. Why? Because when the company is handing out free money, some shareholders will be first in line and others will be last in line. With that said, let's talk about the different types of stock.
The most common type of stock is, as the name implies, common stock. Common stock is like an economy seat on an airplane when it comes to getting distributions. No frills. No benefits. It's the bare minimum flavor of stock someone can own in a company. This means, as far as the company is considered, common stockholders will only get a dividend if the corporation chooses to give them one, and if the company goes out of business and has to liquidate, common stockholders are the last people to get paid from the liquidation if anything is left by the time it is their turn.
Beyond common stock, there are many different types of stock ownership with varying rules and privileges, but a few more you should be aware of:
Preferred stock holders are usually entitled to get some fixed amount of money per year (or upon a specific event, like liquidation). The company must first satisfy its obligations to pay preferred stock holders before they can decide to pay other shareholders, like common stockholders (again, assuming there's anything left after paying preferred stock holders). But what if someone wants the guarantee of payment (like preferred) but the ability to get paid if a dividend is declared for common stockholders? In order for a preferred stockholder to participate in a common stock dividend, they must have a preferred stock with participation rights.
Finally, the last type of stock to be aware of are cumulative preferred shares, which accumulate a dividend, year after year, even if a dividend isn't paid, but must be paid in full when and if a dividend is paid.
The most common type of stock is, as the name implies, common stock. Common stock is like an economy seat on an airplane when it comes to getting distributions. No frills. No benefits. It's the bare minimum flavor of stock someone can own in a company. This means, as far as the company is considered, common stockholders will only get a dividend if the corporation chooses to give them one, and if the company goes out of business and has to liquidate, common stockholders are the last people to get paid from the liquidation if anything is left by the time it is their turn.
Beyond common stock, there are many different types of stock ownership with varying rules and privileges, but a few more you should be aware of:
Preferred stock holders are usually entitled to get some fixed amount of money per year (or upon a specific event, like liquidation). The company must first satisfy its obligations to pay preferred stock holders before they can decide to pay other shareholders, like common stockholders (again, assuming there's anything left after paying preferred stock holders). But what if someone wants the guarantee of payment (like preferred) but the ability to get paid if a dividend is declared for common stockholders? In order for a preferred stockholder to participate in a common stock dividend, they must have a preferred stock with participation rights.
Finally, the last type of stock to be aware of are cumulative preferred shares, which accumulate a dividend, year after year, even if a dividend isn't paid, but must be paid in full when and if a dividend is paid.
Hypothetical
Hypo 1: HypoCorp has 1,000 shares of $1 cumulative preferred stock outstanding, and 1,000 shares of common stock outstanding. The directors chose not to declare a dividend in Year 1 or Year 2, but would like to declare a dividend in Year 3. What must happen in order for common stock holders to get paid a dividend? Result: HypoCorp must first pay $3,000 to the cumulative preferred shareholders (1,000 shares x $1 per share x 3 years) before any dividend can be paid to shareholders without a preference.
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