What is Non-Participating Preferred Stock?

Non-participating preferred stock is preferred stock that specifically limits the amount of dividends paid to its holders. This usually means that there is a specifically-mandated dividend percentage stated on the face of the stock certificate. If the board of directors decides to also pay out a dividend to the common stockholders, this dividend is not also paid to the holders of the non-participating preferred stock. Thus, there is a cap on the amount of distributions allowed to the holders of this type of stock.

Advantages of Non-Participating Preferred Stock

The upside of this situation is that the holders of the preferred stock have a preference right, under which they will be paid before the holders of common stock. This preference right also applies when previous dividends have not been paid - all preferred dividends must be paid before any dividends are paid to the holders of common stock.

Disadvantages of Non-Participating Preferred Stock

The downside of owning this type of stock is that the elimination of a participation right limits the price that an investor can obtain by selling these shares to a third party, since the shares are less valuable.

When to Use Non-Participating Preferred Stock

A company issues non-participating preferred stock when it is under pressure from the holders of its common stock to enhance the payment amounts to which they are entitled. Otherwise, the value of the common shares will decline when it is evident that the preferred shareholders are reserving for themselves a larger proportion of the residual assets of a business.

Example of Non-Participating Preferred Stock

As an example of non-participating preferred stock, a company issues $2 million of non-participating preferred stock. The business is later liquidated, resulting in proceeds of $8 million. The holders of this stock will only be paid their $2 million liquidation preference, while the remaining $6 million is distributed to the common stockholders.