What is preferred stock? How does it impact you, as a startup employee?
TripleLift is a standard corporation, in the sense that it's not a LLC, LLP, general partnership, S Corp, or anything else - so ignore all that, if you've heard anything about those, for the sake of this letter. The company existed on day 1 with only common stock. Each share represented an equal interest in the company. Then we raised money from a VC (the incubator where we got started, which got a little common stock, so they're not relevant for this discussion about preferred shares). VC's will generally invest in a company by buying preferred stock from that company (also convertible debt, but ignore that here). This means that the company issues more stock - the existing stock isn't directly impacted - that have characteristics defined by the preferred terms.
Preferred shares are ultimately defined by the contracts between the buyers and the company. Typically they include provisions around:
Board Composition - different classes of preferred shares may have the right to elect specified members of the board, and certain members of the board may block certain things the company may want to do if they don't agree with it (generally related to financing). The board does things like approve our annual budget, generally opine on certain strategic matters, and discuss potential financing options - and, theoretically, any liquidation event.
Liquidation Preference - in the event that TripleLift sells or IPOs, different classes of shares get different dibs on the money. Debt gets its money back first. Then comes preferred shares, then common. Assuming no debt, and the company sells, here are a few scenarios:
1: We've raised $10M and sell for $5M. Single liquidation. The preferred shareholders get all $5M, and common (all employees, including founders), get $0. Sad face.
2: We've raised $10M and sell for $20M. Single liquidation. The preferred shareholders get the first $10M and the remaining $10M goes to the common. Slightly less sad face.
3: We've raised $10M and sell for $20M. Double liquidation. The preferred now has rights to twice the money they put in, so they get $20M, common gets $0. Sad face.
4: We've raised $10M on a $100M valuation, and sell for $1B. Triple liquidation. Preferred would get $100M that they were otherwise entitled to, by owning 10%, so the liquidation preference isn't important here.
When companies get too zany on valuation, VCs respond by stacking preference. So a lot of the companies that get $1B valuations only get them with 5x or more preference. Basically the VC is saying "OK, have whatever valuation you want, buddy, but we're getting 5x our money before you see a cent." A similar mechanism will apply in "down rounds" when VC ownership can ratchet up.
Dividends - dividends for common stock can generally only be paid from company profits (taxable net income). Not so for preferred shares, which are like debt in the sense that they can have payment obligations. So you might have to pay x% annually, regardless. Or you might have to pay a cumulative amount that would have accrued at x%, sometimes including interest on the otherwise unpaid interest, upon a liquidation event or other specified later date.
Valuation - people get really caught up on valuation, in part because it's a metric of "how _big_ of a company have you got." But hopefully, given the above, you see that it's a fluid conversation where valuation is certainly important, but shouldn't be negotiated in isolation. The valuation is a negotiation, but ultimately the way it's effected is that the company issues new shares for a certain price per share. If we have 100 shares outstanding, and are selling 10 new shares at a price of $5 / share, then you could say the "pre-money" valuation is $500, and the post-money valuation is $550. It's not actually accurate - because the 100 shares don't have the rights that come with the 10 new shares, so they're not "worth" the same $5 as the new shares. So when people ask "what's the company worth" or "what are my shares worth" - it's actually a really complicated question because there's no "true" answer to that (there's a 409a valuation, but that's not exactly accurate for a variety of reasons). But that's why options issued to employees wouldn't be worth $5 in this company. It might be $0.50 or something (valuing options is another topic for another day).