Preferred Stocks

In: Business and Management

Submitted By TempStudent
Words 1989
Pages 8
Background
Hearts ‘R Us (“Hearts”), a young private research and development medical device company, sold $3.5 million of its Series A Preferred Shares on November 30, 2011 to Bionic Body (“Bionic”). This transaction gave the company enough financing for their heart valve system which they hope will revolutionize the way heart valve defects are repaired. In order to make this product available for sale they need a final approval by the FDA. The shares sold to Bionic have a par value of $1 per share and the purchase has given Bionic the following five rights:
Board rights
Mandatory Conversion Right
Contingent Redemption Right
Additional Protective Rights
Right of First Refusal and Co-Sale Rights

After Year 4, Hearts is still in the process of filing for FDA approval. The clinical testing and administrative process for filing for the FDA approval have taken much longer than initially anticipated. In addition, the trial results have been worrisome because of certain post-surgery issues that have been experienced by patients who received the Heart Valve System. It is certain the product will not receive FDA approval by end of Year 5. Hearts had planned to have an initial public offering (IPO) in the future.
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Whether the preferred stocks should be classified (treated) as a (debt/equity) is an accounting issue because of the guidance of the ASC Codification 815-15-25 (Derivatives and Hedging, Embedded Derivatives, Recognition) paragraph 17 shown below;
25-17 Because the changes in fair value of an equity interest and interest rates on a debt instrument are not clearly and closely related, the terms of convertible preferred stock (other than the conversion option) shall be analyzed to determine whether the preferred stock (and thus the potential host contract) is more akin to an equity instrument or a debt instrument. A typical cumulative fixed-rate…...

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