Private Equity/Venture Services

A venture capital firm usually wants to receive "participating preferred" stock.  The term describes rights that can become important in liquidation and, sometimes, dividends.

If the company liquidates, participating preferred stockholders will have an advantage over common stockholders.  First, the preferred status means that the company must pay a specified amount to the holders of the preferred stock before any holders of common stock receive any money.  That preferred amount (called a liquidation preference) may be measured in relation to the preferred stockholders' initial investment plus accrued and unpaid dividends but may be more than that.  When the preferred stock is participating preferred, the holders of the preferred stock will share the remaining pot of cash along with the common stockholders, in addition to the liquidation preference already received.  This means that less money will be available for the holders of common stock.

Participating preferred stock also sometimes (but less often) participates in dividends.  This participation is in addition to the normal preference for dividends that generally accrue on preferred stock.  If and when the company's board of directors decides that the company will distribute dividends to its stockholders, holders of participating preferred stock have priority over holders of common stock with respect to accrued and unpaid dividends.  Plus, they may also "participate" with the common stockholders in the same manner as they participate with the common stockholders with respect to liquidation.