Convertible preferred shares are a type of preferred share that, in addition to granting an extra privilege to its owner, can be converted into common shares in the future.
In other words, convertible preferred shares are a type of preferred share that are characterized by giving the shareholder the option of exchanging them for ordinary shares.
There are many financial assets related to companies, which allow economic returns to be obtained through their acquisition. All of them carry a risk, but also a possible reward.
Among this type of asset, we can find convertible preferred shares. This type of preferred stock carries both the advantages and disadvantages of preferred stock. Along with this, they give the opportunity for the share to be converted into a common share in the future.
At the time of issuance of the convertible preferred share, a conversion rate is agreed at which the share will be converted if the shareholder wishes to make this change in financial asset.
When the shareholder exercises this right, he goes from being a preferred shareholder to an ordinary shareholder.
What is a preferred stock?
Preferred shares are a type of share that grants their owners privileges over ordinary shareholders. These privileges are generally of an economic nature, although they can also be of another type.
Preferred shares usually grant their owner greater hierarchy in collecting dividends from the company or priority in the distribution of the company’s assets in the event of bankruptcy.
This type of share does not have any type of expiration, but does not grant the shareholder the right to vote. As with common stocks, their returns are not guaranteed as they depend on company earnings.
Advantages of Convertible Preferred Stock
In convertible preferred shares we can find three advantages. The first of these is the priority that the shareholder has over the rest in the event of liquidation of the company.
The second one is that, if they make a profit, they will receive higher dividends than ordinary shareholders will receive. In this way, they will obtain a higher profitability than the rest.
Finally, owners of these types of shares have the option to exchange them for common shares whenever they wish. In addition to this, if the price of the ordinary shares is higher than that obtained with the conversion rate, the shareholder will be able to obtain a return on that differential in the event of a sale.
The disadvantages of convertible preferred stock are as follows. The owner does not have the right to vote at the shareholders’ meeting because it is intrinsic to preferred stock.
On the other hand, they are difficult to sell as they are not publicly traded. This means that their liquidity is limited and they cannot be sold at any time.
In conclusion, convertible preferred shares have advantages and disadvantages that should be evaluated by the investor.