Liquidation Preferences

Lesson

Liquidation preferences are the rights of shareholders to receive a specific amount of money before other shareholders when a company is liquidated. These preferences are typically associated with preferred stock, which has priority over common stock in the distribution of assets during liquidation.

Practice Question #1

Which type of equity security has priority over common stock in the distribution of assets during liquidation?

A) Preferred stock

B) Common stock

C) Convertible bonds

D) Warrants

Select an option above to see an explanation here.

A) Preferred stock has priority over common stock in the distribution of assets during liquidation. B) Common stock is subordinate to preferred stock in the distribution of assets during liquidation. C) Convertible bonds are debt securities, not equity securities. D) Warrants are financial instruments that give the holder the right to buy a security at a specific price, not a type of equity security.

Terms

Liquidation:: The process of dissolving a company and distributing its assets to shareholders and creditors.
Liquidation preference:: The right of certain shareholders to receive a specified amount of money before other shareholders during liquidation.

Practice Question #2

What is the main difference between participating and non-participating preferred stock in terms of liquidation preferences?

A) Participating preferred stock accumulates unpaid dividends, while non-participating preferred stock does not.

B) Participating preferred stock allows shareholders to receive additional payments beyond their liquidation preference, while non-participating preferred stock does not.

C) Participating preferred stock has voting rights, while non-participating preferred stock does not.

D) Participating preferred stock can be converted into common stock, while non-participating preferred stock cannot.

Select an option above to see an explanation here.

A) The accumulation of unpaid dividends is a characteristic of cumulative preferred stock, not participating preferred stock. B) Participating preferred stock allows shareholders to receive additional payments beyond their liquidation preference, while non-participating preferred stock only entitles shareholders to their liquidation preference. C) Voting rights are not directly related to liquidation preferences. D) Conversion rights are not directly related to liquidation preferences.

Do Not Confuse With

Dividend preference:: The right of preferred shareholders to receive dividends before common shareholders, which is separate from liquidation preferences.

Practice Question #3

Which of the following terms refers to the order in which different classes of securities are paid during liquidation?

A) Par value

B) Seniority

C) Liquidation preference

D) Dividend preference

Select an option above to see an explanation here.

A) Par value is the nominal value of a security used to determine the liquidation preference for preferred stock. B) Seniority refers to the order in which different classes of securities are paid during liquidation. C) Liquidation preference is the right of certain shareholders to receive a specified amount of money before other shareholders during liquidation. D) Dividend preference is the right of preferred shareholders to receive dividends before common shareholders, which is separate from liquidation preferences.

Historical Example

In the early 2000s, a major telecommunications company filed for bankruptcy, resulting in the liquidation of its assets. Preferred shareholders with liquidation preference returned a portion of their investment, while common shareholders were left with nothing.