Hurdle Shares Definition

What are Hurdle Shares?

Hurdle shares, also known as hurdle stock or hurdle preferred stock, are a type of equity security that pays dividends only after the issuer has met certain performance targets, such as achieving a certain level of profitability or revenue.

How Do They Work?

Hurdle shares typically have a low or no dividend rate until the issuer reaches the specified hurdle. Once the hurdle is met, the dividend rate increases to a predetermined level. The hurdle rate is usually set below the issuer's expected performance, so that the issuer is likely to meet the target and pay dividends to shareholders.

Advantages of Hurdle Shares

There are several advantages to issuing hurdle shares:

• Lower cost of capital: Issuers can raise capital at a lower cost than they would with traditional debt or equity financing, as investors are willing to accept a lower dividend rate in exchange for the potential for higher returns.
• Alignment of interests: Hurdle shares align the interests of investors and the issuer, as both parties have an incentive to see the issuer achieve its performance targets.
• Flexibility: Hurdle shares can be structured to meet the specific needs of the issuer and investors, including the hurdle rate, dividend rate, and maturity date.

Disadvantages of Hurdle Shares

There are also some disadvantages to issuing hurdle shares:

• Complexity: Hurdle shares can be more complex to structure and administer than traditional equity or debt financing.
• Risk: Investors in hurdle shares bear the risk that the issuer will not meet its performance targets, in which case they may not receive any dividends.
• Limited liquidity: Hurdle shares may not be as liquid as traditional equity or debt securities, making it more difficult for investors to buy or sell their shares.

Conclusion

Hurdle shares can be a useful financing tool for companies that are seeking to raise capital at a lower cost and align the interests of investors with their own. However, it is important to understand the potential advantages and disadvantages of hurdle shares before issuing them.