Common Stock vs. Preferred Stock
What is the Difference Between These Stocks and Why it Matters
Why do these stocks matter to startup employees?
I want to go over one of the most important distinctions that one can understand in venture capital, and the distinction is between common stock and preferred stock. If you're a start-up employee or part of a founding team, you need to understand this concept.
For startup employees, what's the difference between common stock and preferred stock? Well, as a startup employee, you will be getting more often than not what's called common stock. These are things like options, they're RSUs or restricted stock. The purpose is that say you have a C-corp company with a million shares, and it's got four starting founders. Well, typically not all the founding four will take all the stock. They won't split it up by 25% meted out equally...and they shouldn't.
Usually, startup employees will be getting common stock granted to them over a four year period.
Instead, they'll leave some in what's called a treasury, so the capital ledger contains a treasury of stock, and this stock is what's called common stock. If you're a startup employee, you will be getting some of these granted to you typically over a four year period. That's the common vesting schedule for common stock with a one year cliff. Those four founders, they might hire somebody like you, and they've allocated, let's say 10% to an employee pool of stock so that after a year, which is the typical cliff for that common stock, you actually get your first grant of common stock.
Preferred stock is different, in that preferred stock is typically what a venture capital firm will negotiate into their investment. Now oftentimes that's Series A, Series B, C, D, etc., but it could actually impact you as an employee, so pay attention.
Preferred stock comes with rights and preferential treatments, for example in merger payouts, voting rights, dividends, things that come along with their investment. If the company and founders have caved and given venture capitalists a lot of preferred rights, let's say a one, two, or three times liquidation preference, those rights can reduce your paths in acquisition.
What do you do? If you're a start-up founder, well, you need to disclose that to your employees. You have an obligation, a moral and I think a fiduciary obligation to make it clear how one will actually acquire stock at your company, okay, company X. If you're a venture capital firm, you should ask startups if they have communicated to the employees how your investment might impact their future rights? That's just our principle, a transparent philosophy at Angel Kings. However, the point being that there is a difference.
As an investor, you need to ask startups if they've communicated to the employees how your investment might impact their future rights?
Common stock is something that vests over time. It never has any preferences so to speak versus preferred stock, which is what the venture capital firms, might negotiate into the contract or the purchase agreement.
Let's say you're an employee. You get common stock. You're a venture capital firm. You negotiate more often than not preferred stock. Here's the point. Startup employees need to understand the terms and conditions that come with your employment investing agreements. Don't sit back and watch. Sign up for our course. Know what's going on.