When a company raises money by selling equity, it can issue different classes of shares with different rights attached — different claims on earnings, different priorities in a crisis, different voting powers. Understanding common vs preferred stock unlocks a lot of what you read in financial news.
Common stock: ownership with full exposure
Common stock (called ordinary shares in the UK) is what most people mean when they say "shares." Common shareholders have voting rights — typically one vote per share — to elect company directors and approve major decisions. They receive dividends when the board decides to pay them, but dividends on common stock are discretionary: the company can reduce or cancel them at any time. The great upside: if the company becomes very valuable, there is theoretically no limit to how much a common share can be worth. Common shareholders capture all the growth.
The trade-off: in a liquidation — if the company goes bankrupt — common shareholders are last in line. They receive whatever remains after all creditors, bondholders, and preferred shareholders have been paid in full. In most bankruptcies, that means common shareholders receive nothing at all.
Preferred stock: the hybrid instrument
Preferred stock sits between bonds and common stock. Like a bond, it pays a fixed dividend — say, 6% of its face value per year — regardless of how the company performs. Like a share, it represents ownership rather than a loan. Preferred shareholders typically do not have voting rights, but they have priority in two critical situations: they receive dividends before common shareholders, and in liquidation they receive their capital before common shareholders.
The core trade-off: protection vs growth
Preferred stock protects you in bad times but limits you in good times. If a company doubles its earnings and its share price rises 200%, preferred shareholders do not benefit — they still collect their fixed 6% dividend and nothing more. Common shareholders capture all of that growth. Conversely, if the company struggles and suspends dividends, preferred shareholders are protected first; common shareholders see their income disappear entirely.
Common stock is like being a business partner — you share in every success and every failure. Preferred stock is like being the landlord to that business — you collect your fixed rent first, but you do not get a cut when the business sells for ten times what it was worth.
Who issues and buys preferred stock?
Companies issue preferred stock when they want capital without giving up voting control or taking on hard debt obligations. Banks and financial companies are heavy users because preferred stock counts toward regulatory capital requirements. The main buyers are institutional investors — insurance companies, pension funds — who value predictable income. Convertible preferred stock is the standard instrument used by venture capitalists when investing in startups: it gives downside protection (priority claim if the company fails) with the option to convert into common stock if the company succeeds spectacularly.