What entrepreneurs need to know about Founders’ Stock. This is a guest post by John Bautista.
John is a partner in Orrick‘s Emerging Companies Group in Silicon Valley. John specializes in representing early stage companies. When entrepreneurs start a company, there are four things they need to know about their stock in the company: Angel Financing – Issue Common or Preferred Stock? Founders contemplating an angel financing often ask whether their company should issue common or preferred stock to angel investors.
A fundamental difference between the two is that preferred stock has a liquidation preference, which upon a liquidation or sale of the company entitles the holder to a payment prior to distributions to the common stockholders. Thus, from the founders’ perspective it is typically desirable to issue common stock so the founders are on parity with the investors with respect to liquidating distributions. Issuing common stock also results in a simpler capital structure as the company will have only one class of stock outstanding (and thus will not be disqualified from making an S corporation election for having more than 1 class of stock outstanding).
Whether to issue common or preferred stock depends on a number of factors, such as: What Rights Come With Preferred Stock? Venture capitalists and sophisticated angels typically insist on receiving preferred stock for their investments in emerging companies. As a result, companies pursuing such investments often ask “what rights come with preferred stock?”
First, it is important to recognize that all preferred stock is not the same. Second, preferred stock terms requested by a venture firm may be a bit more onerous than those sought by angel investors. Typical preferred stock rights and preferences can include: Liquidation preference.