Investment Options Recommendations
Introduction
This paper entails an analysis and review of the available investment options in companies that fall within the start-up economy category. This analysis is based on the specific investment needs of a client who wishes to invest some of his capital in a non-publicly owned firm. The client is 50 years old, and this implies that his investment risk profile is not as high as that of relatively younger investors. In this regard, this paper will advise the client on the stock investment options that are available in his preferred company profiles. Accordingly, this paper will focus on the two categories of stock ownership that are available in non-publicly traded companies. These categories are the common stocks and the preferred shares options. The paper will discuss the main characteristics of the two asset classes, and will conclude by giving a recommendation to the client on the most suitable investment option for him.
Preferred stock refers to a share investment option whose main distinction is that it takes preference in certain aspects over the ordinary common shares of the entity. In this regard, there are four types of preferred stock that the client may consider. The first category is the cumulative preferred shares, which enable the investor to accumulate the company’s dividends during the periods when the company does not issue any dividend payouts. On the other hand, the non-cumulative preferred shares do not contain this accumulation provision. The third category of the preferred shares is the participating option, which enables the investor to receive higher dividend payments in the event that the company records higher-than-expected profit margins. Finally, preferred shares can also be classified as convertible shares, which mean that they can be converted into a specified number of common stocks.
As previously mentioned, preferred shares are paid before common shares during the regular cycle of the dividend payouts. However, this preference provision applies most significantly during the events of insolvency of the underlying company, and it is subsequently forced into liquidation. During this process, the preferred shareholders are paid first alongside the creditors of the company. The remaining funds are then distributed to the common shareholders of the company. This preferential treatment of this category of stock holders implies that their investments are relatively secured from any adverse financial instances that may affect the company. As previously mentioned, this preferential nature of these shares also enables the shareholders to accumulate the dividends of the company during the financial periods when no dividends are paid out based on the recommendations of the board of directors.
The third main characteristic of preferred shareholders is their ability to stake a larger claim to the assets and dividend payouts of the company. These claims are based on the fact that the preferred dividends that these shareholders are entitled to are relatively guaranteed in the payout structure of the company. This provision implies that the board of directors of the company may not recommend a dividend payout during a specific financial period due to a disappointing profit performance. However, the preferred shareholders are still entitled to their payouts since they are guaranteed in spite of the financial performance of the company. This provision is an attractive feature for conservative investors such as the 50-year old client since it ensures that their stock investment is safe, given the non-public nature of the underlying companies at hand.
The fourth main characteristic of the preferred share option is the nature of their dividend payout schedules. The dividends paid by the company to this category of shareholders are scheduled at regular intervals. This provision gives this stock option a relatively fixed-income status in regards to its core characteristics as an investment option. This status is further compounded by the fact that the share price of this stock category does not fluctuate as often, when compared to the ordinary shares category. Furthermore, the fixed-dividend nature of these shares generally implies that this investment class is a hybrid product of the common stocks and bond categories of investments. These combined features of preferred shares imply that they are a viable investment option for a relatively older investor such as the client in question because they provide a safe haven investment option at a relatively higher return level.
One of the main drawbacks of the preferred shares category of investment is the fact that this option does not enable the investor to participate in the company`s voting activities. This outcome is attributed to the fact that preferred shares do not have any voting rights attached to them. This characteristic is a significant consideration for long-term investors who wish to influence the decisions and direction of the company. This characteristic of preferred shares implies that the investors are left to contend with the decisions of the other stakeholders in the company. As a result, the primary interests of preferred shareholders beyond the return on their investments are not represented on the board of directors who are voted to run the company. As a result, preferred investors may only partake in the dividend payouts, but not in the decision-making process of the company.
Ordinary Common Stock
The second stock-holding option which the client may consider in his investment decisions in the non-publicly traded companies is the ordinary common shares category. This category refers to the proportion of the common equity of a company which is readily available for purchase by equity investors. One of the main distinctions between ordinary shares and preferred stock is that the former option contains voting rights, while the latter option does not. In this regard, ordinary common shares can also be classified into two or more categories based on their voting rights. For example, a company may issue Class A common stock, which would have a higher number of voting rights per common share, compared to the Class B category, which would subsequently contain only one right per share of common stock.
The second main distinction between the ordinary common stock category and the preferred share option relates to the payment of their respective dividends. While preferred shareholders are guaranteed of regular dividend payouts, common shareholders` dividend payouts rely entirely on the decisions of the board of directors. In this regard, this board evaluates the financial health of the company at the end of a financial year and it subsequently decides whether or not to issue a corresponding dividend payout during that specific period. Consequently, ordinary shareholders may not receive any dividends over a number of successive years based on the recommendation of the company`s board of directors. However, the company`s preferred shareholders would normally continue to receive their dividends, or they would accumulate these payments and ultimately receive them once the board recommends the issuance of a dividend payout.
Thirdly, the ordinary shareholders of a company are also entitled to pre-emptive rights that are entrenched into their stock-holding positions, once they invest in the company. Pre-emptive rights enable the original shareholders of the company to retain certain proportions of the company`s ownership in the event of subsequent stock offerings as the firm continues to source for funds to expand its operations. These preemptive rights empower the original owners of the entity to retain a significantly larger control of the company, even as new owners continue to invest in the entity. These rights are important to investors who are primarily concerned with the ownership and decision-making structures of the entity, as opposed to the sole pursuit of an increase in their investment`s value and the regular receipt of dividend payouts.
As previously mentioned, ordinary common stockholders are entitled to what is left in the company after the creditors and preferred shareholders are paid during the liquidation and insolvency of the firm. These payment features imply that the common shares of a company are the riskiest investor option when compared to its issued fixed-income securities such as its corporate bonds and its preferred stock. This characteristic of this asset class may discourage potential investors such as the 50-year client because of the uncertainty surrounding the ability to recover their invested capital during adverse economic conditions. However, the underlying assumption during the investing stage in a company is the expectation that the entity will flourish and perform well over the short, medium and long term time frames, based on its underlying fundamentals.
Finally, the risky nature of the ordinary stock of a company implies that the associated return on investment is relatively higher compared to the entity`s other available investment option such as its preferred shares and issued corporate bonds. This return on investment is manifested in the capital gains on the company`s stock price for publicly-traded entities. However, it must be noted that the investment profile of the underlying client in question in this case consists entirely of non-publicly traded entities. In this regard, the anticipated risk-return proposition based on the share’s capital gains may not be adequately manifested. Consequently, the ordinary common stock option may not appeal to an investor of the stature and caliber of the 50-year old client. However, this significant drawback of the common shares category can be compensated by the fact that it is the only asset class which contains voting rights that enable the investors to participate directly in the decision making processes of the entity.
Conclusion
This paper has analyzed and discussed the two main stock investment options that are available in non-publicly traded companies. Although these options are relatively similar to those found in public companies, their specific characteristics might vary slightly due to the fact that these shares are not traded publicly. The two stock categories that have been discussed in this paper are the preferred shares and ordinary common stocks. Their distinct characteristics have been highlighted and duly analyzed in this paper. In closing, it is recommended that the 50-year old client should invest in preferred stocks of the non-publicly traded firms that he prefers, as opposed to ordinary common stocks. This recommendation is made on the basis of the client`s age, which implies that his risk profile is lower than that of a relatively younger investor. In this regard, the investor is guaranteed of a repatriation of his investment capital in the event that some adverse events were to affect his invested companies financially.
