Legal Definitions - dividend preference

Dividend preference refers to a contractual right held by certain shareholders to receive their share of a company's profits, known as dividends, before any dividends are paid to holders of common shares.

Essentially, it establishes a priority system for dividend payouts, ensuring that preferred shareholders are paid first, up to their agreed-upon amount, before common shareholders receive any distribution.

• Example 1: Established Manufacturing Company

  Imagine "Midwest Manufacturing Corp.," a long-standing company that has issued both preferred and common shares. In a profitable year, the board of directors decides to distribute $10 million in dividends. Due to dividend preference, the preferred shareholders, who might have a fixed annual dividend rate, will receive their full payout first. For instance, if their total preferred dividends amount to $2 million, that sum is distributed to them. Only after these preferred shareholders are fully paid can the remaining $8 million be distributed among the common shareholders.

• Example 2: Technology Startup with Initial Profits

  Consider "Quantum Innovations Inc.," a tech startup that has just achieved its first year of significant profitability and decides to issue dividends. Many early investors in startups might hold preferred shares to mitigate risk. If Quantum Innovations generates $500,000 in distributable profits, and its preferred shareholders have a dividend preference totaling $200,000, those preferred shareholders will receive their $200,000 first. The remaining $300,000 would then be available for distribution to the common shareholders, demonstrating how the preference ensures a return for certain investors even in a company's early profitable stages.

• Example 3: Retail Chain Facing Moderate Profits

  Suppose "Urban Outfitters Group," a retail chain, experiences a year with moderate profits, enough to cover some but not all potential dividend payouts. If Urban Outfitters Group has preferred shares with a dividend preference, these shareholders will be prioritized. For instance, if the company earns $1 million in distributable profit and the preferred shareholders are entitled to $750,000 in dividends, they will receive their full amount. This leaves only $250,000 for the common shareholders, illustrating how dividend preference protects the preferred shareholders' payout even when overall profits are not exceptionally high.