What Is A Dividend Preference?
Preferred stock is typically given a dividend preference over common stock, which means that a dividend must be paid to the preferred stock before any dividend is paid to the common stock. There are two types of dividend preferences: non-cumulative, discretionary and mandatory, cumulative.
The former means the company cannot declare dividends on the common stock until a specified dividend is paid on the preferred stock. Mandatory, cumulative requires the company to set aside and pay dividends on the preferred stock at a designated rate.
Most startups don’t generate enough cash to pay dividends and investors often don’t expect actual payments. When dividends are paid, it is typically only when it has been declared by the board of directors.
Companies should be wary of dividends that cumulate. These can have a negative impact on the company’s cash flow and put it at a competitive disadvantage. Unpaid accumulations also generally appear as liabilities on the balance sheet, making it more difficult for the company to borrow money.