What it means
Preferred stock is a type of share that usually pays a fixed dividend and ranks ahead of ordinary shares if the company is wound up. Normally, the exact terms of a preferred share class are written into the company's founding documents and approved by shareholders.
With blank check preferred, shareholders approve the class in advance, but leave the terms blank for the board to complete later. The main advantage is flexibility.
If a company needs capital quickly, the board can create a tailored preferred share and sell it to an investor without waiting for a shareholder meeting. This can help when opportunities are time-sensitive, such as a rescue investment or an acquisition.
The controversial side is the effect on takeovers. A board can issue blank check preferred stock with special voting or conversion rights to a friendly party, making it much harder for a hostile bidder to gain control.
This is the basis of the so-called poison pill defences used by some companies. Investors therefore pay close attention to how large the authorised block is and how it can be used.
Some shareholder groups and proxy advisers prefer limits, such as requiring shareholder approval for issues with special voting rights or for issues used mainly for defence. Governance rules and listing requirements also differ by country.
For finance teams, the key implications are dilution and the cost of capital. Issuing preferred stock can reduce the ownership percentage of existing shareholders, particularly if it converts into ordinary shares, and the dividend is a fixed charge that ranks before payments to ordinary shareholders.
Anyone analysing a company should read the authorised share structure and board powers in the annual report. There is also a signalling effect.
Investors often read a large block of blank check preferred as a sign that the board wants wide room to act, either to raise money or to defend itself. Companies can offset that concern by explaining how the power will be used.
In practice
Real-world examples.
Example
A technology company needs $30 million quickly to buy a competitor. Its board issues blank check preferred shares to an investment fund with a 7% dividend and conversion rights. The deal closes in two weeks, and no shareholder meeting is needed. The 7% dividend adds $2.1 million a year to the company's fixed payments.
Example
A family-controlled manufacturer receives an unwanted takeover offer. The board issues a series of preferred shares with extra voting rights to a long-term partner. The bidder withdraws because it can no longer gain control.
Example
A start-up preparing for a stock market listing asks its shareholders to approve 5,000,000 blank check preferred shares. Investors in the public offering ask for limits on the board's power to use them. The company agrees to require a shareholder vote for any issue with special voting rights. The wording is added to the prospectus, and the listing goes ahead.
Formula
Calculation
Ownership percentage after issue = Shares held / Total shares after conversion x 100
A company has 10,000,000 ordinary shares outstanding, and an investor holds 3,000,000 of them, which is 3,000,000 / 10,000,000 x 100 = 30%. The board issues 5,000,000 blank check preferred shares to a friendly party, and each converts into one ordinary share. Total shares after conversion = 10,000,000 + 5,000,000 = 15,000,000. The investor's stake falls to 3,000,000 / 15,000,000 x 100 = 20%, so ten percentage points of ownership have been diluted without a shareholder vote.Case study
Seen in the real world.
Ashgrove Industries is a fictional listed company whose shareholders had authorised 2,000,000 blank check preferred shares years earlier. When an activist investor began buying ordinary shares and reached 18%, the board feared a forced sale of the business.
In this illustrative story, the directors issued the preferred shares to a strategic partner, with voting rights equal to 4,000,000 ordinary shares. The activist's voting power fell, and several shareholders complained that the board had acted to protect itself. After a public dispute the company agreed to hold a shareholder vote on any similar action in future, and to publish the criteria it would use.
Watch out
Common mistakes.
- Assuming the board can issue any amount of blank check preferred. The authorised number is capped in the company's articles.
- Forgetting that preferred shares can dilute ordinary shareholders. The effect depends on the conversion and voting terms.
- Treating it as only an anti-takeover device. It is also a practical tool for raising capital quickly.
Questions
People also ask.
Why do companies want blank check preferred stock?
It lets the board raise money or respond to opportunities quickly, without calling a shareholder meeting for every deal.
Is it legal?
Many jurisdictions allow it if the founding documents authorise it, but rules and limits vary, so legal advice is essential.
How does it differ from ordinary preferred stock?
With ordinary preferred, the terms are fixed in advance and approved by shareholders, while with blank check the board sets them at the time of issue.
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