So, what is preferred stock? Most corporations can issue multiple classes of stock, usually preferred or common shares. With two classes of stock, certain rights can be reserved for each class, regardless of the relative size of each class. Preferred shares of private companies usually have the right (or obligation) to convert to common shares at a prearranged conversion rate (usually 1 to 1), upon the occurrence of specific timing, such as the sale of the company. Preferred stock also regularly has a stipulated dividend rate.
Legal expenses are generally higher for establishing a preferred class of stock for investors, compared to issuing common shares or a debt instrument. And, for smaller rounds of investment (<$250,000) it may be difficult to justify. However, I still prefer purchasing a preferred security because it sets the stage for subsequent investors. Investing in common shares, on the other hand, can create problems when subsequent investors demand preferred shares at the time of their funding. Investor alignment is best accommodated when all investors own the same class of stock.
What are some of the specific advantages to investors for utilizing a preferred offering? Stay tuned….