Founders Preferred stock is a type of stock that gives founders more control over their company, but it’s not always well-received by venture capital investors. In this article, we will explore the types of Founders Preferred stock, the benefits and drawbacks of using it, and what venture capital investors think about it.
This is a crucial decision for any founder, so it’s important to work with legal counsel to understand what’s best for you. If you’re looking for legal counsel, feel free to reach out to us here.
Super Voting
A few times a year, a first-time founder will ask us to draft Founders Preferred shares like Mark Zuckerberg has with Meta.
Mark Zuckerberg’s controlling stake in Meta, formerly known as Facebook, is due to his ownership of Class B Common Stock. These shares carry super-voting rights, allowing Zuckerberg to maintain control over the company despite owning a relatively small percentage of its overall equity. Specifically, each Class B share carries 10 votes, compared to one vote per Class A share. Though Class A and Class B have the same economic rights, Class B has decision-making power. Even though Zuckerberg owns less than 30% of Meta’s overall equity, he holds over 50% of the voting power, giving him significant control over the company’s direction.
This seems like a founder’s dream right? You can issue Class A to your employees and Class B to founders. Everybody shares in the financial upside, but the founders maintain control of the company as it scales.
However, if the startup is looking to attract venture capital investors, they will run into issues with super-voting shares. Venture capitalists (VCs) oppose super-voting shares for the following reasons:
- Power. It may sound obvious, but if the founders have more power, investors have less. A key reason that investors require preferred shares is to gain more power over founders. Of course, the best-case scenario is that founders and VCs are not in a power struggle, but investors want to ensure that the deck is stacked in their favor if it comes down to it. Super-voting shares removes much of that advantage.
- Reflects Poorly on Founders. VCs may see the super-voting structure as a signal of an arrogant, inexperienced (or both) founding team.
Given the massive amounts of companies VCs look at, it’s simpler just to pass on investing in a company with super-voting stock. But if they still want to invest, they will almost certainly require that all founders and employees are reset to Class A Common Stock.
So, how did Zuck do it? Typically, companies like Meta that have dual and multi-class stock structures create them after the company has achieved a level of success and the founders are being hailed as innovative leaders. It’s possible, but still unlikely, that a super successful entrepreneur may be able to get away with super-voting shares given her track record.
The best advice is to steer clear from super-voting shares if you are looking for venture capital funding.
Alchemy
There is another type of Founders Preferred that is becoming more popular since it has been included in AngelList’s standard documents. These shares do not include super voting, but they allow for a little alchemy. Here’s how it works:
- Day-to-Day. In the day-to-day life of the corporation, these Founders Preferred Shares act just like common shares. They don’t have any voting, dividend, liquidation or other preferences. For all intents and purposes, they are Common Shares just like all other employees.
- At a Financing. However, during a round of financing is when the alchemy occurs. Let’s say a Series A investor wants to purchase shares from a founder (a secondary sale). Then, in that limited window, if the founder sells the Founders Preferred Shares to the investor, these Founders Preferred shares will automatically convert to Series A Preferred Shares, like turning lead into gold.
You may be thinking, “OK, but what’s the big deal? Why does that matter?” It matters very much for founders. Because Series A Preferred Shares have more rights and privileges, they are more valuable. So, this alchemy allows founders to sell their shares for a higher price to the investors than they would if it was simply common stock.
In general, so long as the percentage of Founders Preferred Shares don’t exceed 20%, VCs have been fine with these shares. It’s a win for the investors because, ultimately, they may be the ones purchasing the shares, so it would allow them to have a greater number of shares with higher preferences. It is also a win for founders because it may allow them to liquidate a small amount of shares to gain some liquidity while still building the company.
In conclusion, while super-voting shares may seem like an attractive option for founders looking to maintain control over their company, they are generally not well-received by venture capital investors. So, it’s best to steer clear of super-voting shares if you are looking for venture capital funding. However, there is another type of Founders Preferred that is becoming more popular, which doesn’t include super voting but does allow for a little alchemy.
Ultimately, the key takeaway is to work with counsel to carefully consider what type of shares to issue and how they may be perceived by potential investors. If you’re looking for legal counsel, feel free to reach out to us here.
