Why Preferred Stock is "Preferred" Over Common Stock

The crowdfunding industry has seen a variety of investment instruments over the years. While some platforms suggest founders offer unique instruments like the CrowdSAFE, others recommend selling common stock. Here's why retail investors must have the same opportunities as professional angels and VCs:

1. Equal Rights and Protections: Retail investors deserve the same rights and protections as professionals to avoid being disadvantaged due to less bargaining power or understanding.

2. Simplified Terms: Founders should raise funds with clean, straightforward terms that align with their other investors to prevent complications later.

Many platforms frequently use common stock, which can be problematic. Institutional investors almost always choose preferred stock for its rights and privileges. If VCs won’t invest in common stock, retail investors shouldn't either.

Investor Advantages

Liquidation Preference: This is the most significant benefit of preferred stock, especially crucial for early-stage investments. Preferred stockholders get their money back first in case of liquidation, unlike common shareholders, who are last in line. As Naval Ravikant, CEO of AngelList, explains:

Anti-Dilution Rights: These rights help prevent investment dilution in a down round. If new stock is issued at a lower price later, the investor receives additional shares for free, maintaining their investment value.

Other benefits of preferred stock may include:

• Pro Rata Rights: Allowing investors to maintain their ownership stake as the startup grows.

• First Dividends: Preferred stockholders often receive dividends before common stockholders.

• Tax Advantages: Most preferred dividends are treated as qualified dividends, taxed at the same rate as capital gains.

Company Advantages

Increased Investor Interest: Offering preferred stock can attract more investors due to the abovementioned advantages. Founders offering common stock may struggle to raise capital from sophisticated angels who prefer preferred stock.

Employee Stock Options: Raising funds with preferred stock safeguards the value of stock options, making it cheaper for employees to exercise their options and increase their returns when the company exits. Equity is a major component of compensation packages, helping attract and retain top talent.

Conclusion

Companies raising priced rounds should offer preferred stock to their investors. Retail investors, who are true fans, customers, and early adopters, deserve the same protections as professional investors if their favorite company fails. Providing equal terms also prevents potential harm to employees and the company itself.

While there are rare exceptions where common stock might make sense—such as a hot late-stage company with low risk of failure or a small business with existing common stockholders—enforcing the preferred stock requirement remains in the best interest of both founders and investors.