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If you’ve built a successful company, chances are you’ve raised capital from investors—or plan to. In that process, understanding the difference between preferred stock and common stock is essential. These distinctions matter not only when raising money, but also when hiring employees, structuring incentives, and planning for an eventual exit.
This article focuses specifically on preferred and common stock in the context of equity financings.
Once founders begin fundraising, the terms preferred and common stock come up constantly—especially when dealing with sophisticated venture capital investors. It’s completely normal to find these concepts confusing, both in theory and in practice. While your legal advisors will guide you through the details, having a solid baseline understanding will make the process far less stressful.
Common Stock
Common stock is typically issued to founders and early employees, often in the form of restricted stock.
Restricted stock simply means that the shares are subject to certain conditions on transfer or sale, as set out in documents such as:
- Restricted Stock Agreements
- The company’s bylaws
- The shareholders’ agreement
For example, you may be required to first offer your shares to the company before selling them to an outside third party.
Rights of Common Stockholders
Common stockholders may receive certain rights, such as voting or dividend rights, but these depend on:
- The company’s charter
- Stockholder agreements
- Applicable state corporate law (e.g., Delaware General Corporation Law)
Risk Profile
Common stockholders are last in line during a liquidation event, such as:
- An M&A
- An IPO
- Bankruptcy or dissolution
Creditors and preferred shareholders are paid first. Whatever remains—if anything—is distributed pro rata to common stockholders. If the exit value is lower than expected, common holders may receive little or nothing.
This risk is magnified when preferred shareholders have liquidation preferences (e.g., 1.5x or 2x). In those cases, common stockholders may walk away underpaid—or empty-handed—despite years of effort.
Preferred Stock
Preferred stock comes with additional rights and protections and is typically issued to investors (venture capital firms, angel investors, etc.) during financing rounds.
Key Features of Preferred Stock
Preferred shareholders often receive:
- Liquidation preference (first in line to get paid in an exit or bankruptcy)
- Anti-dilution provisions (helps protect their percentage of the company owned)
- Special voting rights
- Conversion rights, (allows preferred shares to convert into common stock prior to a liquidity event)
Because of these enhanced rights, preferred shares are typically priced higher than common shares, based on the negotiated company valuation.
Why do Investors Care?
Investors are responsible for protecting not only their own capital, but also the money entrusted to them by limited partners (LPs)—such as pension funds, family offices, and sovereign wealth funds. If investors fail to safeguard these funds, raising future venture funds becomes far more difficult. Liquidation priority is one of the primary reasons investors insist on preferred stock, but it’s not the only one. Preferred shareholders are often highly focused on:
- Dilution protection
- Governance rights
- Control provisions
As a result, investors commonly require companies to adopt multiple classes of stock as a condition of investment. While both common and preferred holders want upside, preferred holders are typically more concerned with risk mitigation and control.
Takeaways for Founders
If you’re serious about raising capital from sophisticated investors, issuing preferred stock is almost always unavoidable. That said, founders should carefully evaluate the trade-offs. If investor demands become too burdensome—such as excessive governance rights or aggressive liquidation multiples—it may be worth considering alternatives. Some potential alternatives include:
- Non-dilutive financing
- Debt financing, if favorable terms are available
- Government grants at the regional or national level
At Apex, we work closely with founders to navigate the complexities of equity structures, investor negotiations, and financing strategy. If you’d like guidance tailored to your company, you can book an introductory meeting with us to discuss your options.
