This double agent of stocks could be a strong investment in your portfolio. Most people know that businesses can be private or public. A business may choose to sell common stock or preferred stock. But, what most people do not know is that a public company can also sell private preferred stock.

Public common stock is open to daily stock market fluctuations. Public preferred stock is also open to the public and is also exposed to daily stock market price fluctuation. However, a private preferred stock has all the benefits of a preferred stock, but no public stock market exposure.

Private Preferred Stock

Why would one want to look at private preferred stock versus public preferred stock? In most cases, preferred stocks have a better dividend rate than the common stock. In addition, with a private preferred, it has no exposure to the common shares or stock market fluctuations. This can provide investors with exposure to the company’s revenue without the exposure to stock market risk. There is typically a hold period (usually five years) and then, depending on the security, you can get your money back or convert it to common shares. Depending on the offering, this choice is made for you by the company, or the investor gets to choose. Before you invest, find out what type of exit is involved so that you are not surprised.

Why Would a Company Offer Private Preferred Stock?

If a company issues preferred shares instead of issuing bonds, it can easily show a lower debt-to-equity ratio. This slight change will allow for more lucrative future investments and new investors. A company’s debt-to-equity ratio is one of the most common metrics used to analyze the financial stability of any business. The lower this number is, the more attractive the company looks to investors. Additionally, bond issues can be a red flag for potential buyers. There is a strict repayment schedule that must be maintained, regardless of the company’s financial circumstances, when they are due. Preferred stocks do not follow the same strict guidelines because they are equity issues, which gives them more flexibility with debt repayment.

Shareholders holding preference shares are not given voting privileges. This feature affords a company the ability to issue preferred stock without disturbing the established control dynamics within the corporate framework. In contrast, holders of common stock enjoy a certain extent of voting power, giving them some influence and control. Consequently, firms seeking to maintain the level of control afforded to stockholders, yet looking to create equity positions in their company, may use issuing preferred stock as a strategic move.

Why Would An Investor Desire Private Preferred Stock?

Most shareholders are attracted to preferred stocks because they offer more consistent dividends than common shares and higher payments than bonds. However, these dividend payments can be deferred by the company if it falls into a period of tight cash flow or other financial hardship. This feature of preferred stock offers maximum flexibility to the company without the fear of missing a debt payment. With bond issues, a missed payment puts the company at risk of defaulting. That would cause a credit downgrade and could even force bankruptcy.

New Bells And Whistles Entice Investors

As interest rates have increased, some private preferred dividend rates were no longer competitive. To address this some companies started to use the federal funds rate and add a factor to that. For example, one of the private preferreds we use has this as its way of calculating the dividend it pays on its preferred private stock. Their preferred stock pays cumulative cash dividends equal to Fed Funds +2.5 percent (up to 10 percent and not below 6 percent). The dividend rate is declared quarterly and dividends are paid monthly. Also, if the company is a REIT, then a portion of its preferred stock’s dividend may be tax deferred. In contrast, income from bonds and credit-backed offerings is typically 100 percent ordinary income and taxed at the highest rate.

If you would like to increase the income in your portfolio, decrease your stock market volatility, and have the ability to lock up equity for five years, looking at using a private preferred stock could be for you.

Read more at Forbes.

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Securities are offered through Arkadios Capital. Member FINRA/SIPC. Advisory services are offered through Creative Capital Wealth Management Group. Creative Capital Wealth Management Group and Arkadios are not affiliated through any ownership. This material was created for educational and informational purposes only and is not intended as tax, legal, or investment advice.