What are convertible preferred stocks?

When working with convertible preferred stocks you find that you can transfer your preferred stocks to common stocks after a predetermined amount of time, this also known as convertible preferred shares.

Most convertible preferred stocks are usually exchanged at the request of the shareholder. However there are provisions that allow the company to force a conversion. However, this is rarely done.

The convertible preferred stocks are the type of convertible bond that has a required conversion or redemption feature. Either on or before a contractual conversion date, the holder must change the mandatory convertible into the underlying common stock.

Preferred stock umbrellas are the common form of venture capital financing in which the investors are issued convertible preferred stock while management and founding shareholders hold common stock. The structure is frequently used when management receives its shares at or about the same time as the outside investors.

Participating Convertible Preferred Stock is a class of preferred stock, which is entitled to an additional dividend in addition to the regular dividend, whenever the dividend on the common stock exceeds a certain, amount or yield

The current structuring of a company is set up in order to let the outside investors receive preferred stock while insiders receive common stock can also make it easier for management to use common stock to attract and retain key personnel. This is due to the shares issued to employees must be issued at their fair market value, or the IRS may claim that the recipient must pay taxes on the difference between the fair market value of the stock and the purchase price.

There are certainly pros and cons when looking at preferred shares. Preferred shareholders have priority over common stockholders on earnings and assets in the event of liquidation and they have a fixed dividend, however, investors must weigh out these positives against the negatives, including giving up their voting rights and less potential for appreciation.

If an investor wants to be more of a part of the company they are investing in, they would want to convert their preferred stocks over to common stocks.

There are security options that are similar to a traditional convertible bond in that there is a strike price. This is the cost of the stock when the bond converts into stock. What differs is that there is another price, even higher than the strike price, which the company's stock price must reach before an investor has the right to make that conversion. This is also known as the upside contingency.

The benefits of converting to a common bond from a preferred bond is as follows:

• Represents ownership in a corporation
• Exercise control by electing a board of director
• Voting on corporate policy

A classic convertible preferred stock used by venture capitalist investors also entitles the investor to convert his shares into common stock at a predetermined formula and to vote the preferred stock on issues presented for shareholder vote.

The formula used to convert the convertible preferred stock into shares of common stock on average includes an adjustment mechanism This is called the anti-dilution provision, that protects the investor in his percentage ownership caused by sales of less expensive stock to future investors

Some convertible preferred stocks also permit the investor to require the company to redeem the preferred stock after a predetermined time for an amount that gives the investor a modest profit.

If you are choosing to switch from preferred stock to common stock or vice versa, be sure to read all the provision that go along with the conversion.