Startup companies generally organize their stock into two main classes – common stock and preferred stock – and in some cases also have a third class called founders’ preferred or FF stock.
Common stock is the most basic form of stock a company will issue. It is usually granted to people who have or currently are providing services to the company, including employees, contractors, advisors and directors. Under the law, common stockholders are given the right to vote on certain fundamental company decisions, such as electing board member or significant transactions like an acquisition. Common stockholders also have the right to share in any sale proceeds or distributions from the company.
It’s important to know that only those shares of common stock that are held outright, and not subject to vesting, have these legal rights. In other words, if you are granted stock subject to vesting, only the vested portion of your shares at any given time have these rights.
Also, don’t confuse a stock option grant for common stock. A stock option represents a contractual right to purchase common stock from the company. It’s only once the option is exercised that it becomes stock, the vested portion of which will have these legal rights. To learn more about stock options, check out Paysa’s Fundamentals.
Preferred Stock is generally reserved for investors, strategic partners and financial institutions. Depending on the stage of a company,it may have several series of preferred stock named in accordance with each completed funding round (i.e. Series Seed Stock, Series A Stock, Series B Stock and so on). While the law provides certain rights to all stockholders, preferred stock also carries special negotiated rights that are not applicable to the common stock. In some instances, these negotiated rights supersede or cut back on common stock rights.
The most common right associated with preferred stock can be divided into economic and control rights.
Common economic rights held by preferred stockholders include dividends, liquidation preference, anti-dilution protections, and the right of first offer. Of these, liquidation preference is arguably the one that most impacts the common stockholders. Contained in the company’s charter, a liquidation provision determines the order in which a company will distribute any proceeds from an acquisition or liquidation of the company. Preferred stockholders almost always negotiate to be first in line, after the company has paid off any debt. Usually the preferred stockholders get paid an amount equal to their original investment, though sometimes they negotiate a multiple. For example, if the Series A investors have a 2x liquidation preference, that means they must be paid double the original investment amount before the common stockholders receive anything.
In addition to economic rights, the preferred stockholders also hold certain control and governance rights. These typically include the right to determine the size of and elect a member to the board of directors and the right to veto certain corporate actions such as selling the company, amending the company’s charter or bylaws, or creating a new class of stock.
It’s important to note that preferred stock is convertible into common stock and may be converted at any time by the preferred stockholder or will be done automatically in certain circumstances.
FOUNDERS’ PREFERRED STOCK
Founders’ preferred stock is held only by founders and is a completely separate class of stock from both common stock and traditional preferred stock. It functions as a way for founders to get cash out of the company in the event they need some liquidity. Founders’ preferred stock can be sold to an “accredited investor” and upon sale it converts into the latest series of preferred stock.