What is founders preferred stock?

Takeaway: Very few companies issue founders preferred stock and we generally counsel companies that it’s not worth the expense and effort. Investors often will either require that it is removed or gutted so it is effectively equivalent to common stock. The founders preferred stock rights that we sometimes see survive have an automatic conversion feature allowing founders to sell their founders preferred stock to investors in a financing.

Founders' preferred stock is a type of stock that is issued to the founders of a company as part of the initial equity structure. It is typically issued alongside common stock, which is held by founders, employees, advisors, and investors.

Founders’ preferred stock can have a variety of rights - here are some of the most common:

Priority in liquidation

Founders' preferred stock can have a priority in an acquisition or liquidation over common stock. This means that if the company is sold or liquidated, the holders of founders’ preferred stock will be paid out, up to a certain amount, before the holders of common stock receive any proceeds.

Dividend preference

Founders' preferred stock may also have a dividend preference, which means that holders of founders’ preferred stock are entitled to receive a fixed dividend before any dividends are paid to holders of common stock. The dividend rate is typically fixed at the time of issuance and may be cumulative or non-cumulative.

Conversion rights

Founders' preferred stock may also be convertible into common stock at the option of the holder. This could in theory be used to ensure that the founders control a voting majority of the common stock.

Liquidity through secondary sales

Founders’ preferred stock also sometimes provides an interesting mechanism for founders to obtain liquidity in connection with a venture financing. In essence, the founders can sell their founders’ preferred stock to investors in a financing and when they make the sale, the founders’ preferred stock automatically converts into the series of preferred stock being sold in the financing. The result is that the founder receives cash and the investor receives the new series of preferred stock (same as the other investors).

Control

In some cases, founders' preferred stock may also include certain control provisions, such as the right to elect a certain number of directors or veto certain actions by the company though this is uncommon in startup settings.

Conclusion

Overall, founders' preferred stock is a type of equity that provides certain benefits and protections to the founders of a company. It can help to align the interests of the founders with those of investors and can provide a certain level of financial security in the event of a sale or liquidation of the company. If you are a founder of a startup and are considering issuing founders’ preferred stock, it's important to work with a qualified attorney to ensure that the terms of the stock are structured in a way that is strategic and will be maintained down the road.