When business owners are presented with the option to sell equity for fundraising, they have several options to consider because not all equity shares are created equal. One common approach is the sale of preferred stocks. Preferred stock can be a highly-customized stock offering with unique rights provided to the investors. Each round of preferred stock offered can provide a different variation of rights as outlined in this article. To keep the classes of share organized a capitalized letter is placed behind the share to indicate which version it is such as Class A, B, C, D. A company may offer different classes of shares during their investment rounds for a multitude of reasons including attracting investors or accomplishing a long-term company objective.

Here is a general (non-exhaustive) list of some variations that can be found in the share classes of preferred stock with a short description.

• Liquidation Preference – During the event of a company liquidation, this provision can stipulate the preferred stockholder will be compensated prior to the common shareholders. Company liquidation could include company bankruptcy, merger or sale.
• Preferred vs Guaranteed Dividends – This is a contractual right allowing the holders of the preferred equity to receive dividends from the company ahead of the common or other preferred series holders. In some cases, the provision might actually guarantee dividends, meaning that the company must pay dividends against a certain rate.
• Anti-Dilution – In the event the company sells stock at a lower price per unit (i.e., using a lower valuation, sometimes called a down round) additional stock may be awarded to the preferred stockholder to prevent their percentage of ownership from being diluted. The mechanism usually used to achieve such an award of additional stock is an adjustment to the conversion price attached to that particular class of stock.
• Conversion – Preferred stock often has a provision allowing for the conversion into common stock, against a predetermined and future adjusted price. The reason behind this is to provide the preferred stockholders voting rights, and/or potential economic upside in the event of a sale, merger or other liquidity event that might not otherwise be available to the preferred holder (e.g., the preferred holder has a nonparticipating liquidation preference, meaning that while they are preferred with regard to a certain fixed return against their stock, they may not participate in the additional increase in Company value, unless and until they converted to common).
• Protective Provisions – Often a preferred series of equity units/shares might have special protective provisions that prevent the company from doing certain things that may adversely affect the preferred equity holders (e.g., issue a new, senior, series of equity, with superior rights).

When considering the issuance of preferred shares, if the company intends to provide for any of the above variations, it is typically required to amend its certificate of incorporation to broadly allocate the rights to its Board (if permitted under state law and/or corporate bylaws), or specifically designate the rights pertaining to the newly created shares prior to engaging in the investment round. The company cannot issue shares with the specific terms and conditions, unless and until its certificate of incorporation has been amended with the proper state office.

If your company intends to go through a new round of equity financing, contact our firm to prepare a series of preferred stock tailored towards your fundraising goals.

If you are an investor and would like assistance in understanding the type of stock you intend to invest, and/or help in negotiating rights as an investor, you can contact our firm here.