How can preferred stock become common stock?
We have a client who has common stock in XYZ and she claims those stocks "came" from the preferred stock they use to own? I am assuming that means the preferred stock was sold and then the common stock purchased, but is there another way this could have been done? She has little or no records on this.
Yes, she could have originally owned convertible preferred shares. When the investment was made, she was given preferred stock, but at some point either your client or XYZ caused the conversion from preferred to common. The conversion is generally not a taxable event, so the basis remains the same.
This is common in early stage investments. A young company raises equity, but the stock starts in the form of preferred in case the company doesn't survive. That way the preferred holders will have priority over any assets versus the founders.
It is possible that the preferred shares were converted to common without being sold. As one example, here is a recent offering summary from a Kinder Morgan Mandatory Convertible Preferred Stock deal. These particular preferred shares mature after 3 years at which point they automatically convert to common.
I don’t know if this was the case for your client but I hope it helps.
There is something known as “convertible preferred stock” which can be converted into common stock under circumstances that are specified when the convertible preferred stock is issued. You should be able to get information from the company’s shareholder services department when you ask them if they ever issued convertible preferred stock and what happened to it.