Preferred vs. Common Stock
When a startup or company issues shares, they are typically divided into two main categories: common stock and preferred stock.
Understanding the differences between these two types of shares is essential for both founders and investors.
What is Common Stock?
Common stock is the most basic type of equity in a company. It is typically issued to:
- Founders.
- Employees, through equity plans like stock options (ESOPs).
- Some early-stage investors, such as friends and family.
Key features of common stock:
- Voting rights on key company decisions.
- Residual economic rights: Common shareholders receive payouts only after preferred shareholders have been paid (e.g., in the event of a sale or liquidation).
- Dividends: While possible, dividends are not guaranteed for common shareholders.
Advantage: Common stock allows shareholders to benefit from the company's growth.
Disadvantage: Common shareholders are last in line during a liquidation event.
What is Preferred Stock?
Preferred stock is usually issued to investors, particularly during funding rounds, and comes with certain advantages that make it more attractive compared to common stock.
Key features of preferred stock:
- Liquidation preference: Preferred shareholders are paid before common shareholders if the company is sold or liquidated.
- Dividend rights: Preferred stock often comes with guaranteed dividends, either paid regularly or accrued until payout.
- Conversion rights: Preferred stock can often be converted into common stock under specific conditions, such as an IPO.
- Anti-dilution protection: This protects preferred shareholders if the company issues new shares at a lower valuation than their original investment.
- No voting rights (usually): Preferred shareholders typically do not have voting rights, though this depends on the terms negotiated.
Advantage: Preferred stock offers more security and priority during liquidation events.
Disadvantage: It doesn’t provide the same level of upside as common stock if the company’s valuation grows exponentially.
Key Differences Between Common and Preferred Stock
| Feature | Common Stock | Preferred Stock |
|---|---|---|
| Ownership | Founders, employees, early investors | Institutional or strategic investors |
| Liquidation Preference | Paid last | Paid first |
| Voting Rights | Yes | Usually no |
| Dividends | Not guaranteed | Often guaranteed |
| Conversion Rights | Not applicable | Can often be converted to common stock |
How Capboard Helps Manage Preferred and Common Stock
Managing different types of stock and their associated rights can be complex, especially as your company grows. This is where Capboard makes life easier:
Cap Table Management:
Track and manage all types of equity, including common and preferred shares, in one centralized platform. Capboard automatically calculates ownership percentages, dilution, and more.Liquidation Scenario Planning:
Simulate liquidation events to see how payouts would work for common and preferred shareholders. Understand how different terms, such as liquidation preferences or participation rights, impact payouts.ESOP Tracking:
Manage employee equity plans, including vesting schedules and stock option grants, seamlessly alongside your cap table.Reporting for Investors:
Generate clear and professional reports for investors, detailing their preferred stock terms, liquidation preferences, and any anti-dilution provisions.Data Room:
Store and share essential documents—like term sheets, equity plans, and shareholder agreements—securely with your stakeholders.
With Capboard, founders and investors can stay aligned and maintain transparency, ensuring that everyone is clear on the rights and obligations tied to each type of equity.
Conclusion
Both common and preferred stock play vital roles in a company's structure. While common stock is foundational for founders and employees, preferred stock is a key tool for attracting and rewarding investors. Understanding their differences helps both parties make informed decisions.