Legal Definitions - cumulative stock

Cumulative stock, more formally known as cumulative preferred stock, is a type of ownership share in a company that comes with a special advantage regarding dividend payments.

For most stocks, if a company doesn't pay a dividend in a given period, that payment is simply lost. However, with cumulative preferred stock, if the company misses a dividend payment, those missed payments "accumulate" or build up over time. This means that all accumulated, unpaid dividends must be paid out to the cumulative preferred stockholders before any dividends can be paid to common stockholders.

Here are some examples to illustrate how cumulative preferred stock works:

• Scenario: A Company Recovers from a Downturn

  Imagine "InnovateTech Inc." has issued cumulative preferred stock with an annual dividend of $5 per share. Due to an unexpected economic downturn, InnovateTech struggles for two consecutive years and is unable to pay any dividends to its preferred stockholders. In the third year, the economy recovers, and InnovateTech becomes highly profitable again.

  How it illustrates the term: Before InnovateTech can pay any dividends to its common stockholders in the third year, it must first pay the cumulative preferred stockholders all the missed dividends from the previous two years ($5/share x 2 years = $10 per share), in addition to the current year's $5 dividend. This ensures that the preferred stockholders eventually receive all their promised payments, even if delayed.

• Scenario: A Startup Conserves Cash for Growth

  "GreenFuture Energy," a new startup, raises capital by issuing cumulative preferred stock to early investors, promising a semi-annual dividend of $0.75 per share. For its first three years, GreenFuture Energy decides to reinvest all its earnings back into research and development and expanding its operations, choosing not to pay any dividends to conserve cash.

  How it illustrates the term: After three years (six semi-annual periods), GreenFuture Energy successfully launches its product and starts generating significant revenue. Before the company can distribute any profits to its common stockholders, it must pay the cumulative preferred stockholders the total of all missed dividends ($0.75/share x 6 periods = $4.50 per share), plus any current dividends due. The "cumulative" feature protects these early investors by ensuring their dividends aren't simply lost during the growth phase.

• Scenario: Acquisition of a Struggling Business

  "RetailRevive Co." has cumulative preferred stock outstanding with an annual dividend of $3 per share. For four years, RetailRevive experiences financial difficulties and misses all preferred dividend payments. In the fifth year, a larger competitor, "MegaMart Corp.," decides to acquire RetailRevive.

  How it illustrates the term: As part of the acquisition agreement, or before any proceeds from the sale can be distributed to RetailRevive's common stockholders, the cumulative preferred stockholders must be paid their accumulated $12 per share (4 years x $3) in missed dividends. This demonstrates the priority of cumulative preferred stock, ensuring that even in a significant corporate event like an acquisition, the accumulated unpaid dividends are settled before common stockholders receive anything.