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is a form of convertible preferred stock that provides the holder with extraordinary rights in the event the company is sold or liquidated. In that event, the holder receives back his purchase price for the stock and, possibly, some guaranteed return on that purchase price and then receives, in addition, his pro rata share of the remaining sale or liquidation proceeds with all other shareholders. The following example illustrates how a ‘participating’ feature in a convertible preferred stock affects the investor’s and management’s return on investment. The example assumes the investor purchases 1 million shares of convertible preferred stock for $5 million when management owns 4 million shares of common stock. The illustration shows the investor’s and management’s return if the company later sold for $10 million or $100 million.
Like convertible preferred stock, participating preferred stock also provides the holder with defined preferences over the holders of the company’s common stock. These preferences typically include enhanced voting rights, liquidation and dividend preferences, convertibility into common stock and antidilution protection. Because of the extraordinary sale and liquidation preference in participating preferred, companies usually agree to sell participating preferred only when they receive a meaningful price or other concession in return. Also, whenever possible, management will negotiate a sunset provision into the preference that makes it inoperative after a passage of time or in a sale or liquidation that would generate an agreed upon minimum return without the preference. See: Antidilution Provisions, Convertible Preferred Stock, Convertible Securities, Preferred Stock Umbrella. |
