Restrictive covenants the restrictive covenants in a

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Unformatted text preview: ith the current dividend, must be paid before dividends can be paid to common stockholders. Restrictive Covenants The restrictive covenants in a preferred stock issue are aimed at ensuring the firm’s continued existence and regular payment of the dividend. These covenants include provisions about passing dividends, the sale of senior securities, mergers, sales of assets, minimum liquidity requirements, and repurchases of common stock. The violation of preferred stock covenants usually permits preferred stockholders either to obtain representation on the firm’s board of directors or to force the retirement of their stock at or above its par or stated value. Cumulation Most preferred stock is cumulative with respect to any dividends passed. That is, all dividends in arrears, along with the current dividend, 314 PART 2 Important Financial Concepts noncumulative preferred stock Preferred stock for which passed (unpaid) dividends do not accumulate. conversion feature (preferred stock) A feature of convertible preferred stock that allows holders to change each share into a stated number of shares of common stock. must be paid before dividends can be paid to common stockholders. If preferred stock is noncumulative, passed (unpaid) dividends do not accumulate. In this case, only the current dividend must be paid before dividends can be paid to common stockholders. Because the common stockholders can receive dividends only after the dividend claims of preferred stockholders have been satisfied, it is in the firm’s best interest to pay preferred dividends when they are due.1 Other Features Preferred stock is generally callable—the issuer can retire outstanding stock within a certain period of time at a specified price. The call option generally cannot be exercised until a specified date. The call price is normally set above the initial issuance price, but it may decrease as time passes. Making preferred stock callable provides the issuer with a way to bring the fixed-payment commitment of the preferred issue to an end if conditions in the financial markets make it desirable to do so. Preferred stock quite often contains a conversion feature that allows holders of convertible preferred stock to change each share into a stated number of shares of common stock. Sometimes the number of shares of common stock that the preferred stock can be exchanged for changes according to a prespecified formula. Issuing Common Stock venture capital Privately raised external equity capital used to fund early-stage firms with attractive growth prospects. venture capitalists (VCs) Providers of venture capital; typically, formal businesses that maintain strong oversight over the firms they invest in and that have clearly defined exit strategies. Because of the high risk associated with a business startup, a firm’s initial financing typically comes from its founders in the form of a common stock investment. Until the founders have made an equity investment, it is highly unlikely that others will contribute either equity or debt capital. Early-stage investors in the firm’s equity, as well as lenders who pro...
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