Convertible preferred stock is a type of preferred stock that has the option of being converted into common shares issued by the same company. The terms and conditions that apply to the stock normally set the conditions that must apply before the conversion can take place. Generally, the terms outlined at the time of purchase also define the ratio of conversion from the convertible preferred stock to shares of common stock.
Convertible preferred stock is one of the less commonly employed approaches of issuing shares of stock. Usually there are some underlying factors that preclude the issuing of straight common stock. One scenario that often applies to the issuing of convertible preferred stock is that the company is currently considered to be in a high risk situation, and needs to raise capital quickly. Within this scenario, the company finds that raising money through equity or through the accumulation of temporary debt will not adequately address the current circumstances.
In the actual structure of the issue of convertible preferred stock, the investor usually receives a dividend that is configured in a manner that is similar to a bond issue. It is also not unusual for the convertible stock option to also specify a point in time when the stock will be subject to conversion into common stock. This option makes it possible for the company to convert the stock at a point when conditions become more favorable for the issuance of common stock, and thus retire the convertible preferred stock option.
Convertible preferred stock does not necessarily constitute a higher risk than many other types of investments. In fact, if there is reason to believe the issuer of the stock will experience an upcoming period of prosperity in a reasonable period of time, the stock option can turn out to be quite lucrative. However, it should be noted that careful investigation into the current status of the issuer, as well as accurate projections of future performance, must be undertaken before choosing to go with a convertible preferred stock purchase.