Classes of Stock and Preferences

I am not a lawyer, an accountant, an SEC licensed anything, or a real expert in this field. Having said that, I have been involved in setting up classes of stock, preferences, and similar matters for many companies by now. So these are the things I have discovered over time so far. This discussion is about private equity, not public companies, which is a whole different world.

What are the preferences?

As far as I can tell, there is no way to tell all the possible preferences that can exist. In essence, as long as it's not illegal or restricted by regulation, a preference can be contractually defined to be anything the contracting parties wish. You could probably have a preference that the CEO will personally go to a particular homeless shelter each week and wash the feet of all the people in the lunch line. Of a CEO might not be willing to sell you those shares under that condition.

I have personally seen the following types of preferences in actual investment instruments:

Classes of stock

Typically, classes of stocks are listed as Class A, B, etc. But as I understand it, the name of a class of stock has nothing to do with the preferences, or at least it doesn't have to.

Different classes of stock can also be bought and sold at different prices. A reasonable valuation for a company that has recently sold equity in all of its different classes would/could/might be the sum of the sale price times the number of issued shares of each type.

However, when you sell equity in a private growth company, you are selling the promise of future value, not necessarily what the last folks paid for it. But if you offer the same thing to different people at different prices, they may be very unhappy, and they may have a right to sue. My understanding is that you have to disclose the history of such transactions to the extent they effect other people.

Shares are prorated ownership of the company, but as these various rights come into play, things get complicated, and of course lacking voting and other similar rights creates inequities that, if they become too extreme may result in legal actions.

But as I say, there are apparently no hard and fast rules. So what this means is you have to read the subscription agreement, identify, and properly understand the preferences in place.

A few examples

In any contract, parties are taking risks for rewards. Preferences are negotiable aspects of contracts between the parties. Who goes first, who pays before or after the other performs, how the exchanges take place, etc. are all more or less important to different parties because of their perspectives.

These examples of preferences and the reasoning behind them should help understand the exchange that gets negotiated in preferences for investments. But do you really understand the implications of these things? Of course nobody knows everything about what the future may hold, but there is sometimes a lot of subtlety in negotiations of this sort, particularly when it comes to the effects of these decisions on the future value of the company to the different parties.

A call to action

We help grow companies!

If you want us to help you develop your strategy for preferences and classes of stock and equity, we do that as part of our advisory board service and in workshops. If you are enthusiastic about getting and receiving help, embrace the help we can provide.

We offer FREE resources! Use them!!

Want to do a presentation and see if we can help you further?

Go To Angel

But consult your SEC licensed securities law firm before you make any actual decisions about legal issues such as these.

Next month... Dilution!!!

The discussion of equity, preferences, investment instruments, etc. is really more meaningful in the context of the issues of dilution. So make sure to read next month's article when it comes out to get the rest of this picture.

In summary

Now that you know more than I do about this subject, check with your lawyers and send me updates so I can find out what I got wrong here and how to fix it...

We are all learning all the time.

Copyright(c) Fred Cohen, 2020 - All Rights Reserved