Preference shares have been defined as shares with a higher right to dividend and repayment of their investments when compared with ordinary shares. This type of shares can be classified further. In this lesson, we will consider participating preference shares.
Definition of Participating preference shares
Let us define it in two ways:
Definition base on dividend
This is a type of preference shares that have the right to the second batch of the dividend after ordinary shareholders are paid.
Definition base on liquidation
In the event of liquidation, this class of preference shares receive a second share to the assets of the company after ordinary shareholders have been paid their share of assets.
After preference shares will receive the dividend as every other preference shareholders. Then, which ordinary shares will be paid dividends. Next, if the board of directors sees reasons to declare more dividends, participating shareholders will be privileged to receive the second round of such dividends.
In the event where the company liquidates or stops operation, holders of these stocks will be paid their investments from the assets of the companies. These preference shareholders will receive their money along with other holders in the same rank.
Next, holders of ordinary shares will be paid their investment from the assets as well. However, where every party entitled to receive a share of the assets of the company have been paid. And there is more income (from the assets sold available) for sharing, participating preference shareholders will also receive a share from the assets.
Generally during liquidation, the assets are shared on a pro-rata basis. This is based on the number of shares or investments the holder has with the company.
For example, if a participating preference shareholder has 30,000 shares of the total 300,000 participating preference shares. And the value of assets to be shared is 2 million Naira.
On a pro-rata basis, he will receive 30,000 ÷ 300,000 × 2,000,000. With your calculator, the answer shall be 200,000 Naira. This is what will be given to this shareholder.
Venture capital firms use this method on companies they have investment funds. VCs firms investments are usually categorised as preference shares. Until when they exist in the company.
When there is a compulsory takeover or a merger and acquisition of such companies, the VCs may request for a further share of the assets sold. This will only be possible if every other shareholder has received every penny of their investments in the company.
To conclude, participating preference shares are shares that received additional income by participating in the further sharing of either dividends or assets of the company. The reverse of Participating preference shares is non-participating shares and is being discussed in the article on investing.