Dividends may be paid on a fixed schedule at a fixed rate, or the schedule and rate may vary based on revenue, income, or another specified measure of company performance.
The first example is the least flexible of the dividend payment approaches. The parties may agree to defer the start of dividend payments and also subject the total dividend payments to a cap. Absent a cap, the company will be obligated to make the dividend payments at the stated rate and in accordance with the agreed upon schedule until either 1) the stock is redeemed or 2) the company is sold or otherwise liquidated.
In the second example, the company is obligated to pay a dividend on a fixed schedule, but the amount of the dividend will vary based on the company’s financial performance. One advantage to this approach over a variable payment debt obligation is that there is no fixed legal limit to the annual return paid to investors, as would be the case with debt. But the payment of the dividends may be subject to regulations that would prevent payments to shareholders in amounts that would render the company insolvent.
- Fixed rate dividend
Sample language: Cumulative dividends at an annual rate of X percent compounded [monthly] OR [quarterly] OR [annually] shall accrue on the outstanding Preferred Stock and shall be paid on at least a [monthly] OR [quarterly] OR [annual] basis. Additionally, dividends will be paid on the Preferred Stock on a [participation ratio, e.g., “1:1”] basis when and if paid on the common stock.
- Variable basis amount (no minimum)
Sample language: The Preferred Stock will carry a cumulative dividend (the “Participation Share Amount”). The Participation Share Amount will equal X percent of the Company’s [monthly] OR [quarterly] OR [annual] (the “Measurement Period”) [Gross Revenue]OR [EBITDA] OR [Free Cash Flow] OR [Net Income]. The Participation Share Amount for each Measurement Period shall be paid within [specify time period] after the end of the applicable Measurement Period. Additionally, dividends will be paid on the Preferred Stock on a [participation ratio, e.g., “1:1”] basis when and if paid on the common stock.