The critical difference between common and preferred shares, highlighting why understanding preferred shares is crucial for founders.
The critical difference between common and preferred shares, highlighting why understanding preferred shares is crucial for founders to avoid ending up with nothing after a successful exit. It emphasizes the importance of structuring equity correctly from the outset.
Hello, everyone. This is Alejandro Cremades, and today we’re going to be talking about what are preferred shares? There are different types of shares that you are going to have to encounter when you are a startup founder. You’re going to have the common, you’re going to have the preferred, but what are the preferred shares, and why are they given to investors? In today’s video, we’re going to cover it, we’re going to break it down for you, and we’re going to give you all the insights. So, with that being said, let’s get into it. Knowing your stocks and the types of shares is critical because it’s not only about the type of exit that you’re going to do, meaning who is going to acquire your business, and what type of acquisition that’s going to be. But also, what’s going to be your personal exit because, in many instances, you see so many companies that have raised so much money, but the
founders end up with absolutely zero. You need to be very careful and structure things the right way so that you don’t end up stuck holding the bag. That’s why you really want to know your shares and understand the different classes, and in this case, why the preferred shares are so critical. In terms of what are preferred shares? You’re going to have two types of shares essentially as a startup founder. You’re going to have on one end, the common shares, which are the ones that you give to founders, to the team, to directors, to advisors, and then you’re going to have the preferred shares. The preferred shares, in a sense, they are given to the outside investors that are coming in and making an investment in your business, and in essence, just like the name suggests, those investors will get preferential treatment. The types of classes of shares that you have play a critical role when
you are getting your business acquired, especially if the valuation of the business is lower than the last valuation on the last financing round that you did. Obviously, the higher the valuation, they’re good for everyone, and everything is fantastic. Everyone is happy, but when you’re selling the business for a lower amount, based on the valuation that you did on your last round of financing, investors are not going to be happy, and the types of classes of shares that they have are going to determine where they are in the line in order to cash out as investors. In terms of why investors want preferred shares, it’s very simple. They are investing in the business, and they’re hoping to get a return over the course of time, and the way that you can negotiate an exit is going to determine how they can do and how many returns they can get for that investment that they placed. The way that
you can negotiate an exit, an acquisition, a secondary sale, an IPO is going to determine what they can take out, and that’s why the preferred shares give them the preferential treatment that gives them that peace of mind of knowing that at least if you do a poor job, as least they can take the money out of the equation before you’re able to cash out yourself with the other common shareholders. That’s why the preferred shares are something the investors really want just for peace of mind, especially when cashing out. When you are choosing a type of shares that you are going to be giving to investors, you’re going to need a corporate lawyer there reviewing everything to make sure that nothing is going to come and bite you because those preferred shares, in many instances, they come with liquidation preferences meaning that maybe they get two times or three times or whatever that is, the
amount of money back before you ever get the opportunity to cash out. Let’s say, imagine they get 2X liquidation preferences, and the company gets acquired for maybe $20 million. The last valuation you did was around $10 million. Then, they get double the amount of money out before you’re ever able to cash any money out. That’s what happens with the liquidation preferences, so that’s why you want a really good corporate and securities lawyer that is helping you and guiding you every step of the way. We would love to hear what you’re up to and what kind of round you’re dealing with on the comment section below. Also, Like this video, and don’t forget to subscribe to the channel so that you can follow all the new videos that we’re rolling out every week. Then, take a look at the fundraising training, which is the program where we help entrepreneurs from A to Z with everything related to
fundraising. There you’ll find live Q&As, templates, agreements, a community of founders helping each other all over the world, and you’ll find tremendous value in it. Thank you so much for watching.