As mentioned here previously, from time to time we are going to give a brief primer on common terms and issues in venture financings. Today, we’re tackling the mechanics and underlying purposes of two of the more common dividend provisions.
Generally, start-up companies do not generate substantial amounts of cash, but nevertheless many venture financings include provisions affording the preferred stockholders either cumulative accruing dividends or non-cumulative “when, as and if declared” dividends. Neither dividend provision is likely to have an immediate impact on a start-up’s cash position, business prospects or governance, leading some entrepreneurs and lawyers to gloss over them, however they factor into the economics very differently in a company sale.
Cumulative accruing dividend provisions ordinarily state that at issuance each share of preferred stock begins to accrue either a set dollar amount (non-compounding) or a percentage of the share’s original purchase price (either compounding or non-compounding), whether or not the company has the cash on hand to pay the dividends and whether or not approved by the company’s board of directors. This type of provision effectively adds to the preferred stock’s liquidation preference as time goes by until ultimately being paid when the company is sold.
Non-cumulative “when, as and if declared” dividend provisions also ordinarily state that at issuance each share of stock begins to accrue a set dollar amount per year, but that’s where the similarities end. If the company did not approve a non-cumulative “when, as and if declared” dividend come the end of the year, it is extinguished and begins accruing anew the following year and ultimately will not to be paid until approved by the company’s board of directors. While this type of provision does not automatically add to the preferred’s liquidation preference, it is often accompanied with a provision requiring that the “when, as and if declared” dividends be paid before dividends on any more junior class.
This post on Equity was authored by Ryan Sansom.