Can Non-Institutional Investors Purchase Preferred Stock?

Preferred stock is a type of equity in a company, offering investors certain advantages over common stock, such as priority in dividends and liquidation. While much of the preferred stock market is underpinned by private investments in early-stage companies, it is possible for non-institutional investors to invest in preferred stock under certain conditions. This article will explore the avenues available to such investors and the criteria they must meet.

Understanding Preferred Stock

Preferred stock represents ownership in a company, akin to common stock. However, it comes with specific rights and features that distinguish it from regular stock. These include:

Precedence in dividend payments, with preferred shareholders often receiving a fixed dividend before common shareholders are paid. Priority in asset liquidation during bankruptcy or dissolution. Convertibility into common stock or voting rights under certain circumstances.

Given these advantages, preferred stock is often favored by investors seeking stability and protection. However, the accessibility of such investments has historically been limited by the requirement for accredited or sophisticated investors.

Accredited Investors: The Traditional Path

The primary way non-institutional investors have traditionally purchased preferred stock is through private equity transactions. Accredited investors, who meet specific financial criteria, are the main participants in these investments. The status of an accredited investor can be determined by either a net worth test or an annual income test:

Net worth test: Individuals must have a net worth exceeding $1 million, excluding the value of their primary residence. Income test: Individuals must have had an annual income of $200,000 or more for the last two years, or a joint income with a spouse of $300,000 or more, and expect to maintain that income level.

The income test applies to individuals, while the net worth test can also be met by entities or by joint couples, who must not have ancestors as sole or equal contributors to their net worth exceeding 35%.

Alternative Routes: Brokerage Platforms for Non-Institutional Investors

Alongside traditional private equity investments, there are now platforms that cater to non-institutional investors, offering them the opportunity to invest in preferred and common stock of privately held companies. Notable platforms include EquityZen and SharesPost. These services facilitate ‘brokered trades’ where private company stock is traded among sophisticated investors, similar to how stocks are traded in public markets.

Qualifying as a Sophisticated Investor

While non-institutional investors can now participate in these platforms, they still need to qualify as sophisticated investors. To be considered a sophisticated investor, an individual must:

Have at least $1 million in liquid assets, excluding equity in their primary residence. Agree to waive any conflicts of interest, as these platforms are designed to handle information asymmetry between buyers and sellers. Trade with parties who have more detailed information about the company than the investor does. This ensures transparency and fairness in the transaction process.

Sophisticated investors are essentially individuals who are well-versed in financial markets and can make informed decisions based on the available information. This status helps maintain the integrity of the market and ensures that investors have access to the necessary information to make sound decisions.

Conclusion

The landscape for non-institutional investors looking to purchase preferred stock has evolved significantly. From the traditional avenues of private equity transactions to the emergence of sophisticated investor platforms like EquityZen and SharesPost, there are now more accessible options available. However, these opportunities still come with stringent requirements, underscoring the importance of financial preparedness and market knowledge.

For those considering such investments, it is crucial to understand the specific qualifications and requirements. Whether through the traditional methods or the newer, more inclusive platforms, the path to preferred stock investment remains well-defined, just more accessible than in the past.