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

From the perspective of investors, there are several advantages associated with the use of non-participating preferred stock, which are as follows:

Priority over common stockholders. Non-participating preferred stockholders receive fixed dividends before any dividends are paid to common stockholders. This provides a steady income stream and some level of financial security, especially in stable companies.
Priority in liquidation. In the event of a company liquidation, non-participating preferred stockholders have a higher claim on assets than common stockholders. This priority can be beneficial if the company's assets are insufficient to pay all stakeholders fully.
Reduced risk. Non-participating preferred stock typically attracts risk-averse investors. While they won’t receive additional dividends if the company’s profits soar, they also avoid the downside of common stock price volatility, creating a more stable investment option.

There are also advantages for the issues of non-participating preferred stock, which are as follows:

Reduced equity dilution. Non-participating preferred shares don't increase in payout with company profits beyond their fixed dividend rate. This preserves more of the company’s future earnings for common stockholders, making it attractive to owners and founders who want to retain equity value.
Fixed dividend obligation. Since the dividends on non-participating preferred stock are fixed, the company can plan for its cash flow needs without worrying about increasing dividend payments as profits rise.
Attracts conservative investors. Non-participating preferred stock is often appealing to conservative or institutional investors seeking income stability. By issuing this type of stock, companies can tap into a broader investor base without giving away a portion of the upside.
Provides a flexible capital structure. Issuing non-participating preferred stock allows companies to raise capital without taking on additional debt. This provides financial flexibility, as preferred stock often doesn’t count against debt covenants and may improve the company's credit profile.

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.