Venture capitalists and sophisticated angels typically insist on receiving preferred stock for their investments in emerging companies. As a result, companies pursuing such investments often ask “what rights come with preferred stock?” First, it is important to recognize that all preferred stock is not the same. Second, preferred stock terms requested by a venture firm may be a bit more onerous than those sought by angel investors.
Typical preferred stock rights and preferences can include:
- Liquidation preference
- Dividend preference
- The right to convert to common stock
- Anti-dilution protection (meaning, purchase price anti-dilution protection)
- Blocking rights on significant actions of the company (e.g., company sale, equity financings, increase in option pool, etc.). Sometimes these rights can extend to governance matters such as the right to approve the appointment of senior executives, to incur significant indebtedness, etc.
- Rights of first refusal with respect to transfers of stock by the founders and sometimes other shareholders
- A co-sale right to sell stock on a pro rata basis if the founders sell stock
- Right to appoint a member(s) to the company’s board of directors
- Rights to participate on a pro rata basis in future equity offerings of the company
- Rights to demand that the company engage in a public offering and/or register the investor’s shares for sale into the public market
- Information and inspection rights
The extent to which a company will be required to grant such rights will depend on the context of the financing, including the type of investors (e.g., venture capitalists or angels), the relative leverage of the parties and the rights granted by the company in prior financing rounds. With respect to the last point, a company should recognize that the rights it granted in its last financing round will serve as the starting point for its investors in the current round. These investors will typically get at least those rights or better.