Practices and Industries
Putting A Cap On Participating Preferred Stock
Participating preferred stock - which entitles the investor to a preferential payment upon liquidation, as well as a share of the remaining liquidation proceeds with common stockholders - has some critics, namely those who say it allows the holder to double-dip into the company gains. A common way to limit the dilution of value caused by participating preferred stock is to set a cap on the participation amounts. With this structure, the holder gets all the benefits of participating preferred stock, but the total return on invested capital is capped, unless the holder gives up its liquidation preference and converts to common stock (greater aligning its interest with the founders' interests).
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