Common vs. Preferred Stock: Understanding the Differences

For founders, understanding the distinctions between common and preferred stock is vital, as each type has different rights, privileges, and implications for your company’s financial and governance structure.

Rights and Privileges

Common Stock:

• Equity Ownership: Represents a share of ownership in the company.
• Voting Rights: Typically comes with voting rights, allowing shareholders to vote on corporate matters like electing the board of directors.
• Profit Sharing: Shareholders are entitled to a share of the company’s profits, usually in the form of dividends, although these are not guaranteed.

Preferred Stock:

• Priority on Assets and Earnings: In case of liquidation, preferred stockholders get paid before common stockholders.
• Dividend Preference: Preferred stock often comes with a fixed dividend, paid out before any dividends to common stockholders.
• No Voting Rights: Usually, preferred shareholders do not have voting rights, though this can vary.

Voting Rights

• Common Stock: One of the key advantages of holding common stock is the ability to influence the company’s direction through voting.
• Preferred Stock: Typically lacks voting rights, but in some cases, these rights might be granted, especially in specific circumstances like when dividends are not paid.

Dividends and Liquidation Preferences

• Dividend Payments:
  • Common Stock: Dividends are not guaranteed and are paid after preferred stock dividends.
  • Preferred Stock: Generally receives dividends before common stock and often at a fixed rate.
• Liquidation Preferences:
  • Common Stock: In a liquidation event, common stockholders are last in line after debts, creditors, and preferred stockholders.
  • Preferred Stock: Has priority over common stock in liquidation, often receiving their investment back before any proceeds are distributed to common stockholders.

Conversion and Anti-Dilution Provisions

• Conversion Rights (Preferred Stock): Many preferred stocks come with the option to convert into common stock, offering flexibility to investors, especially in cases where the company’s value increases significantly.
• Anti-Dilution Provisions: Protects investors from dilution in future funding rounds. This means if new shares are issued at a lower price than what preferred shareholders paid, they receive additional shares to maintain their percentage ownership.

Conclusion

For founders, the choice between issuing common or preferred stock can have significant implications. While common stock allows more control and a direct share in the company’s success, preferred stock can be attractive to investors seeking more security and stability. Understanding these differences is essential for making informed decisions about your company’s equity structure and fundraising strategies.