Angel Investing: What Is a Preferred Stock?

Preferred Stocks Are Issued In Series

Unlike common stock, preferred shares are issued in series to represent each round of financing. For instance, Series A typically refers to the first round, Series B the second, Series C the third, and so forth.

* This is Part 2 of a 3-part series. Visit Part 1 at “Angel Deals: Quick Discussion on Common and Preferred Stocks.”

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Rights granted to investors of later series typically rank ahead of preferred shareholders in earlier series and common shareholders. That is, rights held by Series C investors would have more weight than Series B and Series A investors, who in turn rank higher than common shareholders; and rights held by Series B investors would have more weight than Series A investors and common shareholders. As they say, new money always has more power.

Experienced angels are careful as to the requests they make in early rounds. They know that their terms will set a precedent and that later investors will always want more rights than existing investors. Smart angels know that they might end up hurting their economic benefits by demanding onerous terms in the early stage. Their advice to new angels: Don’t complicate early stage deals.

Preferred Rounds Difficult To Justify For Small Rounds

The structure of preferred shares is more complicated than that of common shares because of the extra features (e.g., liquidation preference and anti-dilution protection, among others) that come with preferred stocks. The legal fees for a preferred round, if done properly, are around US $50,000. This makes preferred deals more difficult to justify for small rounds.

In general, experienced angels who don’t accept convertible notes usually request preferred shares if the round is larger than US $500,000. One angel said he requests preferred stocks if the round exceeds US $250,000, but added that he rarely invests in rounds of such small size, i.e., less than US $500,000.

For contextual purposes, angels who are willing to use convertible notes may accept capped notes in seed rounds between US $250,000 and US $1 million, according to the observations of Yokum Taku, corporate and securities partner at Wilson Sonsini Goodrich & Rosati, from January 2010 to January 2011. [2]

Again, though convertible notes are out of context in this brief, you may learn more about convertible debt deals in “Starting Investing: What You Need to Know About Convertible Notes (2nd Edition).”

Up next: When Do Seasoned Angels Invest in Common Stocks?