Don’t Get Shafted, Understanding Your Share Options

As a founder, understanding the different types of shares you can issue is crucial for building a successful company. Two primary categories are preferred shares and common shares. While both represent ownership in a company, they come with distinct characteristics that can impact your business significantly.

Preferred Shares: Attracting Investors

Preferred shares are often issued to investors, particularly in venture capital financing rounds. They offer a unique set of benefits that make them attractive to investors seeking a balance of income and potential appreciation. Preferred shareholders have a higher claim on assets and earnings than common shareholders, receiving dividends before common shareholders and taking precedence in a liquidation event. This priority in receiving dividends and recouping their investment in a liquidation event offers investors a level of security compared to common stock. (read more: Silicon Valley Bank)

One key advantage of preferred shares is their potential for higher dividend rates compared to common shares. However, they also carry risks for both the investor and the company. The issuer can redeem the shares at a certain price, potentially limiting capital appreciation for the investor. Additionally, preferred shares typically don’t come with voting rights, giving investors less say in company matters. (read more: Investopedia)

It’s important to note that not all preferred shares are created equal. Different classes of preferred shares may have different rights. For example, in later financing rounds, matters can become more complex and potentially unfavorable for founders, especially if the company has struggled to hit milestones. In these situations, investors might ask for 2x or 3x liquidation preferences or anti-dilution provisions. (read more: AngelList)

Common Shares: Rewarding Employees and Founders

Common shares represent direct ownership in a company and offer the potential for growth through capital appreciation. Common shareholders have voting rights, giving them a say in company matters. While dividends are possible, they’re not guaranteed and can be cut or eliminated. Common shares tend to be more volatile than preferred shares, experiencing higher price fluctuations. In a liquidation event, common shareholders are the last to receive any remaining assets. (read more: Carta)

Choosing the Right Share Structure for Your Business

The decision of how to structure your shares depends on your business goals, fundraising needs, and long-term vision. Preferred shares can be a powerful tool for attracting investors, while common shares are essential for rewarding employees and maintaining founder control.

Conclusion

Understanding the differences between preferred and common shares is crucial for making informed decisions about your business’s financial future. Preferred shares offer a way to attract investors while providing them with certain protections, while common shares are key for incentivizing employees and maintaining founder control. The choice of how to structure your shares depends on your specific business needs and goals.

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