What is a shadow series and how is it used in convertible note and SAFE financings?

Takeaway: A “shadow series” of preferred stock ensures that SAFE and convertible note holders who convert at a discount or valuation cap only receive liquidation and dividend rights based on the lower price they actually “paid,” rather than the higher price paid by new cash investors.

When SAFEs or convertible notes convert in a preferred stock financing, the holders usually buy in at a discount or a valuation cap, which gives them a lower effective price per share than the new investors. Without careful structuring, those investors could inadvertently receive a windfall by getting all the rights of the new preferred stock—such as liquidation preference and dividends—calculated at the higher cash price, even though they invested at a lower price.

What is a Shadow Series?

To avoid this mismatch, the company’s charter creates a parallel series of stock—often called Series A-1 Preferred Stock—just for the converting investors.

  • New cash investors purchase Series A Preferred Stock at the actual financing price (e.g., $1.00/share).

  • SAFE/note holders convert into Series A-1 Preferred Stock at their lower effective price (e.g., $0.80/share).

Why It Matters

Here’s the key issue:

  • If the new investors are paying $1.00 per share, each of their shares carries a $1.00 liquidation preference and dividends calculated on $1.00.

  • If a SAFE holder converts at $0.80 per share (because of a 20% discount), giving them shares of the exact same series would entitle them to a $1.00 liquidation preference and dividends on $1.00—an unintended windfall, since they only “paid” $0.80.

The shadow series solves this by giving SAFE/note holders stock with the same rights and protections as the new preferred—except their liquidation preference and dividends are based on their lower effective price ($0.80 in this example).

The Benefit

  • Fair to new investors: Prevents convertible holders from getting more preference than they paid for.

  • Fair to early investors: Still delivers the benefit of their discount or valuation cap, just without layering on unintended extra value.

  • Cap table clarity: Keeps the records clean by separating the two groups of stock, making financings, audits, and exits easier to track and explain.

The shadow series is a standard, widely used tool in venture financings. It ensures that everyone—both new investors and early convertible holders—gets exactly what they bargained for.

Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.