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What is Redeemable Preferred Stock?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 24 August 2016
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    Conjecture Corporation
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Sometimes known simply as preferred stock, redeemable preferred stock is a type of stock option that carries the possibility of being returned by the investor to the issuing entity after certain provisions within the terms and conditions of the original sale have been fulfilled. Typically, this means that the shares can be redeemed once the unit price of the shares reaches a certain level, or once a specific date after the sale date has passed. In some cases, there is a need for the holder of the redeemable preferred stock to notify the issuing entity ahead of time of the intent to cash in the shares in order for the transaction to actually take place.

Due to the structure of redeemable preferred stock, many companies that issue this type of offering will include some incentives for investors to hold onto those shares for an extended period of time. One of the more common incentives is the inclusion of a higher rate of interest with the issue, in comparison to other types of preferred stock currently issued by the company. When coupled with an attractive schedule for providing dividend payments to shareholders, there is a very good chance that investors will prefer to hold onto the shares over the long-term, rather than make use of any provisions to cash in the shares as soon as the basic terms related to the sale of the shares have been met.

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Along with providing incentives for investors to hold onto the redeemable preferred stock, trade laws in a number of countries also place limits on when investors may exercise their right to sell the shares back to the issuing entity. One example of these types of limits is the inability to induce the issuer to buy back the shares when the transaction would create significant financial hardship and threaten to undermine the operation of the company. The idea behind these kinds of governmental regulations is to prevent mass runs on certain companies during times of economic downturn. By doing so, the chances of additional company shutdowns that force more people out of work and make economic recovery more difficult is minimized.

The actual process for liquidating redeemable preferred stock often involves holding the shares for a specified period of time before approaching the issuer about buying them back. For example, the terms of the original sale may call for the investor to not exercise this option for at least one calendar year after the initial purchase. At other times, the terms of the sale may prohibit the investor from seeking to cash in the preferred shares with the issuer until the unit price of the shares reaches a certain amount. Even then, many trade terms will require that the investor notify the issuer in advance of his or her intent to exercise the option to sell back the shares, giving the issuer time to allocate the financial resources needed to honor the request.

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