Preferred Stock (like Common Stock) is a security that represents ownership in a corporation. In addition to the ownership interest, Preferred Stock has rights that Common Stock does not. For example, in US venture-backed companies, Preferred Stock typically carries a liquidation preference, which allows it to get paid ahead of Common Stock (but after debt) in a liquidation or sale of the company. Preferred Stock may also have other economic rights, such as the right to receive dividends before the Common Stock. The Preferred Stock often carries specific voting rights as well; the holders of Preferred Stock often have the ability to elect one or more members of a company’s Board of Directors, and to veto certain significant corporate actions.
US venture capital investors generally favor Preferred Stock as the instrument for their investments. Hence, Preferred Stock is the security that companies almost always sell to investors in a Series Financing. The specific rights of Preferred Stock in any given financing are a matter of negotiation. For guidance on negotiating key terms of a Series Financing, please see this article.
Preferred Stock is often described as either “non-participating” or “participating” Preferred Stock. This distinction refers to what the holders of the Preferred Stock would receive in a liquidation or sale of the company. In a liquidation or sale, holders of “non-participating” Preferred Stock have to choose between receiving their liquidation preference or getting paid alongside the Common Stock based on their ownership percentage, but do not receive both. In contrast, holders of “participating” Preferred Stock first receive their liquidation preference, and then also receive payment alongside the Common Stock based on their ownership percentage. “Non-participating” Preferred Stock is used much more frequently than “participating” Preferred Stock in US venture deals. For up-to-date information on the frequency on these and other important terms of Preferred Stock, please see our Trends page.