The Basics of Preferred Stock

What is preferred stock?

Owning stock or shares gives an investor equity or stake in a company. Preferred stock defines a particular class of stock that carries certain rights and privileges for investors above and beyond what common stock offers.

For example, and what usually carries the most weight from an economic point of view, holders of preferred stock take precedence in the event the company is sold in a merger or acquisition (and also in the event of other liquidation events). In other words, investors holding preferred stock will be paid out before the holders of common stock. Another set of key privileges are anti-dilution rights, which in essence enable investors to get more stock as compensation for a company in subsequent funding rounds, so their equity or stake is not “diluted” by the influx of subsequent shareholders. For more on this subject please read “Understanding Anti-Dilution Provisions”.

Should a startup offer preferred stocks?

Preferred stock has been the tried and true method that traditional venture capital firms have used. It allows them to give funds to the startup while positioning them favorably in the case of widespread success or, in the alternative, liquidation. It enables VC’s to take risks on startup companies and gives startup entrepreneurs some bargaining chips in determining the conditions of receiving funding.

This blog does not provide legal advice and does not create an attorney-client relationship. If you require legal advice, please contact an attorney directly.