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What exactly are dividends?

Startup and Private Valuations: What happens to unpaid pref. dividends when pref shares are converted to normal share?

  • Can they continue to exist as due pref dividends with priorities over normal share dividends etc. OR do they have to be converted into normal shareholder loans or normal share dividends due?

  • Answer:

    The terms of a preferred financing set out whether or not a company has to declare a dividend.  If a dividend is never declared, it doesn't exist, and in most cases the company doesn't have to declare a make-up dividend. If the company declares a dividend but does not pay it out (generally, because it does not have the funds) the declared but unpaid dividend amount is typically added to the liquidation preference, which must be paid out before any common dividends or liquidation proceeds.  The conversion ratio (the number of shares of common stock that will be exchanged for a share of preferred) is a formula based on a company's liquidation preference - usually the liquidation preference as of the time of conversion divided by the original liquidation preference (as adjusted for stock splits, recapitalizations, and so on).   If the preferred stock had a 1:1 conversion ratio and, say, a $2 preference as of issuance, and has accumulated $0.20 of declared but unpaid dividends, the liquidation preference is now $2.20 and the conversion ratio is 1.1:1.  In this example, if there is a conversion the preferred shareholders would now receive 1.1 shares for every share of preferred stock, and the liquidation preference and dividend obligation are extinguished with the conversion.

Gil Silberman at Quora Visit the source

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Typically, everything is negotiable.   Dividends are either "cumulative" or "non-cumulative," meaning that, in the case of cumulative, the holder is entitled to a dividend whether or not declared by the Board at the rate and on the terms set forth in the company's charter.  In the case of non-cumulative dividends, however, the holder would only be entitled to a dividend if and when a dividend is declared by the Board and, in such event, the dividend would be typically at the rate and on the terms set forth in the charter.  So, whether the holder is entitled to any accrued and unpaid dividends will be determined by the holder's rights as set out in the company's charter.   Similarly, if the holder, at the time of conversion, is entitled to any accrued and unpaid dividends, whether they continue to exist after conversion, or how they are treated in the conversion, will be determined by the company's charter.  In many charters, all accrued and unapid dividends terminate at the time of the conversion; that is, the holder will forfeit the dividends at the time he or she converts the preferred stock into common stock.  In other cases, I have see them convert into common stock on the same terms as the underlying preferred stock.  So, in sum, you will need to check the company's charter to see how they are to be handled.   Disclaimer:  All of my responses on Quora are subject to the Disclaimer set forth in my Quora Profile.

Bart Greenberg

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