Preferred stock

External investors, especially VCs, typically demand preferred stock with enhanced rights compared to common stock, the fundamental ownership unit in a company. These rights prioritize preferred shares in a liquidation event. We distinguish two:

Non-participating preferred stock

aka “straight preferred,” this liquidation preference grants investors a predetermined multiple of their initial investment before common stockholders receive any payment. Subsequently, the investor doesn’t partake in additional distribution of proceeds. This preference is highly advantageous to other shareholders, contrasting with Participating Preferred Stock.

Participating preferred stock

aka “double-dip preferred,” this preference grants investors a predetermined multiple of their initial investment before common stockholders, and also allows them to share proportionately in the distribution of remaining proceeds. This effectively results in the investor being paid twice in a liquidation event.
Given its potential impact on other shareholders, founders may negotiate a cap on the liquidation preference. This cap limits the total return to the investor, beyond which they no longer participate in additional proceeds. This variant is often termed “capped participating preferred” or “partially participating preferred.