When a small business incorporates, they issue common stock to its investors. Common stock represents a percentage of ownership in the company. Common stock shareholders are entitled to voting rights regarding company issues such as stock splits and appointing board members and officers. Preferred stock is another category of stock in which investors can also own. Unlike common stock, preferred stock entitles the holders to have “preferred” treatment in the event that the company needs to liquidate. Other words, investors of preferred stock are paid first before common stock holders. Preferred stock holders do not have any voting rights which makes issuing preferred stock a more attractive choice when raising capital.
Organize a meeting with the company board of directors and approve the issuance of preferred stock. A two-thirds majority vote is typical unless the corporate bylaws say other wise.
Decide on a number of dollars that need to be raised through the preferred stock offering. Outline the use of proceeds from the preferred stock offering and show the investors how you intend on compensating them for their risk.
Choose a dividend rate that the company can afford to pay to its preferred stock holders. The rate should be competitive to what a bank would offer in a CD. Decide whether to structure the dividend to be Cumulative or Non-Cumulative. Cumulative simply means that if the company skips any dividend payments, it gets accumulated and paid to the shareholder once the company resumes paying the dividends. Non-Cumulative do not make up any missed dividend payments.
Prepare an offering memorandum which contains all the details of the preferred stock offering such as share price, dividend, redemption and the risks. The memorandum should also contain a subscription agreement which explains how investors can purchase the stock.
Distribute the offering memorandum to friends and business associates. Address any questions they might have with regards the company and to owning the preferred stock. Be sure to remain compliant with SEC rules regarding private placements. Read up on Reg D 504 to 506 rules. All contacts with investors should already have a pre-existing relationship with them before providing any documents.