Startup Lawyer | What is Preferred Stock?
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What is Preferred Stock?

Posted 14 Jul 2008

Most startups issue only common stock. But sometimes a startup will encounter a situation, such as raising capital, where having more than one class of stock is beneficial (or required). When startup companies raise capital through the issuance of stock, they typically issue “preferred stock” to their investors.

Definition of Preferred Stock

Preferred stock is a class of stock that provides certain economic and control rights and protections not given to the holders of a startup’s common stock (the founders usually hold the common stock). Hence this class of stock is “preferred.”

Typical economic rights of preferred stock include a liquidation preference, anti-dilution protection, and conversion rights. Control rights deal with a host of voting issues and electing the board of directors.

Which Investors Receive Preferred Stock?

Preferred stock is most commonly issued when a startup undergoes a large financing, such as one with a venture capital fund. Angel investors and the friends & family round may sometimes receive preferred stock. Keep in mind there is no bright-line rule when it comes to angels and the f&f round.

Other than the Capital Raised, Does the Startup Benefit from the Issuance of Preferred Stock?

It sure does. Since preferred stock comes with economic and control rights and protections, common stock typically gets a lower valuation for the purposes of stock option grants or share issuances to the corporation’s employees. Employees can generally exercise their common stock options at a lower price than the price of the preferred stock. Thus, employees may feel as though they are receiving some sweat equity for their contribution to the corporation.

11 Comments
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    Posted at 10:14h, 17 July Reply

    […] stock requirement is fatal to a venture capital investment since venture capital firms will demand preferred stock in return for their investment. Also, most venture capital firms are organized as limited […]

  • 5 Signs Your Startup Jumped The Shark | The Startup Lawyer
    Posted at 15:39h, 20 July Reply

    […] – You offer to pay your pizza delivery guy by issuing him common stock, and he counters with preferred stock and a 10x liquidation preference. Share this […]

  • What is a Pre-money and Post-money valuation? | The Startup Lawyer
    Posted at 13:48h, 31 July Reply

    […] valuation. 3,000,000/(5,000,000+3,000,000)= 37.5%. Google owns 37.5% of your startup company (in preferred stock) while all the other shareholders of your startup company own the remaining 62.5%. Share this […]

  • Benjamin
    Posted at 19:42h, 01 April Reply

    Ryan, I stumbled upon your website today on accident and its the best find I've had in awhile. I'm taking you advice on scraping my LLC and going with a C-Corp, but am not sure how much preferred stock to start with. If I am anticipating (in a perfect world) 2 rounds of funding and giving up at least 50% of the company, then should I start with at least 50% of the stock as preferred?
    Keep up the good work, its has helped me a lot in just a day.

  • Benjamin
    Posted at 14:42h, 01 April Reply

    Ryan, I stumbled upon your website today on accident and its the best find I've had in awhile. I'm taking you advice on scraping my LLC and going with a C-Corp, but am not sure how much preferred stock to start with. If I am anticipating (in a perfect world) 2 rounds of funding and giving up at least 50% of the company, then should I start with at least 50% of the stock as preferred?
    Keep up the good work, its has helped me a lot in just a day.

  • Ryan Roberts
    Posted at 16:01h, 07 April Reply

    Benjamin,

    I wouldn't start out with any stock as preferred. You can amend the charter later to add a 2nd class of shares.

  • Ryan Roberts
    Posted at 11:01h, 07 April Reply

    Benjamin,

    I wouldn't start out with any stock as preferred. You can amend the charter later to add a 2nd class of shares.

  • Raj Kato
    Posted at 17:39h, 18 November Reply

    Hi Ryan,

    I'm in the process of seeking funding for my startup internet company name YourKandy.com. We've created an Interactive Social Network Magazine that targets the entertainment Industry, such as: Models, Actors, Directors, Writers, etc…
    I have a 40 page business plan with a 5 year financial projection forecast ready to hit the laps of investors. But as you know it's not that easy. All these financial terms and equations are new too me and I just want to make the least mistakes as possible on something i've worked so hard on.
    I'm more then confident I will succeed, if i've gotten this far, but not by myself, always through the help of amazing people like you who help others in the start of a fascinating journey.
    Any advice you can give for my situation, especially where to look for added investors, not only in the money they can provide but most importantly the experience they add to a startup company?

  • Raj Kato
    Posted at 12:39h, 18 November Reply

    Hi Ryan,

    I'm in the process of seeking funding for my startup internet company name YourKandy.com. We've created an Interactive Social Network Magazine that targets the entertainment Industry, such as: Models, Actors, Directors, Writers, etc…
    I have a 40 page business plan with a 5 year financial projection forecast ready to hit the laps of investors. But as you know it's not that easy. All these financial terms and equations are new too me and I just want to make the least mistakes as possible on something i've worked so hard on.
    I'm more then confident I will succeed, if i've gotten this far, but not by myself, always through the help of amazing people like you who help others in the start of a fascinating journey.
    Any advice you can give for my situation, especially where to look for added investors, not only in the money they can provide but most importantly the experience they add to a startup company?

  • Convertible Note Term Sheet | Startup Lawyer
    Posted at 09:30h, 24 August Reply

    […] like the preferred equity financing process, the convertible debt financing process can start with a term sheet, rather than […]

  • Angel Investors: Give Them Common or Preferred Stock?
    Posted at 03:47h, 03 July Reply

    […] angels get common stock or preferred stock?  What’s the difference between common stock and preferred stock?  Why does it matter?  This deal term has implications for future funding rounds and your […]

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