Cumulative Preferred Stock: Everything You Need to KnowStartup Law ResourcesVenture Capital, Financing
Cumulative preferred stock is a type of preferred stock that accumulates unpaid dividends if a company stops dividend payments and increases safety for holders.3 min read
2. Example: Cumulative versus Non-Cumulative Preferred Stock
3. Why Is Cumulative Preferred Stock Important?
4. Reasons to Consider Using Cumulative Preferred Stock
5. Reasons to Consider Not Using Cumulative Preferred Stock
6. Ask a Lawyer
What Is Cumulative Preferred Stock?
Cumulative preferred stock is a type of preferred stock that provides a greater guarantee of dividend payments to its holders. The “cumulative” in cumulative preferred stock means that if your company suspends dividend payments, the unpaid dividends (known as dividends in arrears) owed continue to accrue.
If you decide to restart dividend payments, you must pay all accrued dividends to cumulative preferred shareholders before making any dividend payments to common shareholders. Non-cumulative preferred shareholders, on the other hand, would only be paid dividends from the time your company restarts its dividend payments, and would have no right to receive payment for dividends in arrears.
The cumulative return can be represented as a percentage using the formula: ((Current Price of Security) - (Original Price of Security)) / (Original Price of Security)
Preferred stocks are similar to bonds with fixed payments, but bonds have priority on company assets and bonds proceeds are considered to be a liability while preferred stock proceeds are considered an asset.
Other types of preferred stock may include:
Participating preferred stock and nonparticipating preferred stock
Callable preferred stock
Convertible preferred stock
Example: Cumulative versus Non-Cumulative Preferred Stock
Assume that you issue preferred shares with a $5 per share annual dividend that begins in 2017. In 2019 and 2020, your business suffers a downturn and suspends dividend payments. In 2021, your business recovers and you are able to restart dividend payments.
If your preferred shares are non-cumulative, you can pay dividends to common shareholders in 2021 immediately after you pay the $5 per share dividend for 2021 to preferred shareholders.
If the shares are cumulative, you cannot pay dividends to common shareholders until you pay all current and accrued preferred dividends. To pay dividends to common shareholders in 2021, you would need to pay preferred shareholders a total of $15 per share for the 2019, 2020 and 2021 dividends.
You may also spread the payments out over time. For example, you could pay preferred shareholders a $10 per share dividend in 2021 to cover 2019 and 2021, followed by $10 per share in 2022 to cover 2020 and 2022. In this case, you may start paying dividends to common shareholders immediately after the 2022 dividend payment to preferred shareholders.
Why Is Cumulative Preferred Stock Important?
The cumulative feature offers an investment advantage to cumulative preferred shareholders. It also provides your company greater leverage to ask a higher price for preferred shares, and in negotiations with investors over other shareholder rights such as voting.
Reasons to Consider Using Cumulative Preferred Stock
Companies often use cumulative preferred stock for the following reasons:
The guaranteed cumulative dividend means investors have reduced risk and are willing to pay more per share.
The reduced risk can also lead to a lower fixed dividend amount vs. non-cumulative shares.
Greater protection makes cumulative preferred shareholders more comfortable in giving up voting rights or board representation, as opposed to non-cumulative preferred shareholders.
Reasons to Consider Not Using Cumulative Preferred Stock
Your company may wish to avoid cumulative preferred stock for the following reasons:
The requirement to pay accumulated dividends will likely delay when you are able to resume dividend payments to common shareholders.
Paying accrued dividends means that your company will also have less cash available for operating expenses and investments.
Other financing options may be more cost-effective.
Ask a Lawyer
To learn more about whether cumulative preferred stock is right for you and to get help issuing stock, find a securities lawyer in your area. UpCounsel's lawyers have an average of 14 years of experience and are available on-demand to help your business grow.