Common stock is what founders, employees and advisors own. Preferred stock is what investors buy in a priced round. Preferred comes with a liquidation preference (investors get their money back first on a sale), protective voting rights and often a board seat. Common gets what is left, which is why the 409A price of common is lower than the price investors pay for preferred.
Key takeaways
- The liquidation preference is the defining feature of preferred stock.
- The market standard at seed and Series A is a 1x non-participating preference with a right to convert to common.
- Everyone who works for the company, including employees, advisors and contractors, gets common stock or options on common. Preferred is for investors.
- Aggressive preferred terms in one round tend to carry into the next round.
How do common and preferred stock compare?
| Common stock | Preferred stock | |
| Who holds it | Founders, employees, advisors | Investors in priced rounds |
| Price | Lower; set by a 409A valuation after the first round | The price negotiated in the round |
| On a sale or liquidation | Paid after the preferred | Paid first, up to its preference, or converts to common |
| Voting | Votes on stockholder matters | Votes with common, plus separate votes on protective provisions |
| Board | Often elects founder directors | Often elects one or more investor directors |
What is common stock?
Common stock is the basic ownership interest in a corporation. Founders buy it at formation, and employees and advisors receive it through restricted stock or options. Common stockholders vote, share in profits if dividends are ever paid (startups rarely pay them) and get whatever remains on a sale after the preferred has been paid.
There is no difference in class between shares issued to employees, advisors or contractors. All service providers get common stock or options to buy it.
What is preferred stock?
Preferred stock is issued to investors in priced rounds, starting with a seed or Series A. SAFEs and convertible notes convert into preferred stock in that round. The preferences are set out in the company’s charter and the round documents, and typically include a liquidation preference, protective provisions (matters that need the preferred holders’ consent), anti-dilution protection and, often, the right to elect a director. See Protective Provisions and Anti-Dilution.
What is a liquidation preference?
A liquidation preference means that on a sale or wind-down, preferred holders get their investment back before common holders receive anything. With the standard 1x non-participating preference, the preferred holder gets the greater of its money back or what it would receive by converting to common.
Example: Investors buy 20% of the company for $5,000,000 at 1x non-participating. If the company sells for $20,000,000, 20% would be only $4,000,000, so the investors take their $5,000,000 preference and common shares the remaining $15,000,000. If the company sells for $50,000,000, 20% is $10,000,000, so the investors convert to common and take that instead.
Higher multiples (2x) or participating preferred (money back and a share of the rest) shift more of the sale price to investors. See Liquidation Preference.
Why is common stock priced lower than preferred?
Because the preferred has rights the common doesn’t, especially the liquidation preference, a share of common is worth less than a share of preferred. A 409A valuation reflects that discount, which is what lets employees receive options at a lower exercise price than investors paid. See 409A Valuation and How to Value Startup Stock.
Should founders hold preferred stock?
Usually not. Founder preferred is a special class of founder stock that can be converted into the next round’s preferred so a founder can sell a small amount to investors in a later round. Most founders don’t need it, and investors look closely at it when they do see it. See Founder Preferred Stock.
How do preferred terms affect my next round?
New investors rarely accept worse terms than earlier investors got, so whatever you agree to in one round tends to become the floor for the next. A high liquidation multiple, participation or unusually broad veto rights in a seed round can make a Series A harder and shrink what common holders receive on a sale. Investors take real risk and are entitled to standard protections. Negotiate for standard terms at each stage, not for the highest headline valuation.
Go deeper: For a full walkthrough, see our Founder’s Guide to Seed Funding and Founder’s Guide to Series A.
For standard priced-round documents, see Series Seed vs NVCA Docs, our Series Seed service and NVCA Series A service. If you’d like help negotiating preferred terms, contact us.
