This is a big deal (term).

SHARES AREN’T FAIR.

On the surface, startup investing can seem simple. Pick a great idea + strong founders, then cruise to profits.

Realistically, there's a lot more that goes into it, particularly around the exact terms of each offering.

Today I'm going to break down the difference between Preferred and Common shares.

But first, some of this week's top links:

• 💡21 big shifts in 2024 that are you can invest in or build a business around (LINK)

• 🕵️‍♂️ Behind-the-scenes look at building CROWDSCALE (LINK)

• 🍻 The $62M fund that specifically buys…whiskey barrels (LINK)

• 💼 5 tax strategies to save you thousands on your startup investments (LINK)

• 💧Household wells are making a comeback - here’s why I’m investing in the space (LINK)

WHAT’S THE DEAL?

I prefer preferred…

Many startups tend to raise money through the issuance of company shares. Investors give money to receive ownership shares at a pre-determined price per share.

There are two distinct types of company shares: Common and Preferred.

Common shares typically go to the founders and employees. Despite this, they are the less desirable type of company shares. This is because they don't have the same protections as Preferred shares.

Preferred Shares are typically given to investors and come with special terms to protect downside risk.

During an exit or liquidation event, money is always given to preferred shareholders first - and there's no guarantee that there will be any money left by the time it reaches common shareholders.

This is because of a special term within Preferred Shares called a liquidation preference. If a startup and investor agree on a 1x liquidation preference, the investor must be paid 1x their original investment before any common shareholder receives money.

Let's say a startup raises $200k at a $50M valuation.

• An investor named Pete invested $100,000 into the company to receive Preferred Shares at a 1x liquidation preference.

• Another investor, Cam, invests $100,000 as well but receives Common Shares.`

The company struggles, and is forced to sell their assets at firesale prices for $125,000.

Because Pete has Preferred Shares, he's first in line to claim that cash. Due to his 1x liquidation preference, he's able to claim $100,000 - or 1x the amount he originally invested.

Cam doesn't have those same protections and by the time it gets to him, there's only $25,000 remaining for him to take.

Cam is actually lucky in this case. Had Pete negotiated a 1.25x liquidation preference, he would have taken the entire $125,000.

As you can see, it is always beneficial to have Preferred Shares in a company. Venture Capitalists will almost never accept deal terms where the startup is offering common shares.

Some startups that raise capital online through crowdfunding are offering Common Shares, knowing that unsophisticated investors won't notice the difference.

Some currently live deals that are offering common shares: Wigl, Acme Atronomatic, Flower Turbines. There’s many.

While it's best practice to only invest in Preferred Shares, it's not the end of the world to own Common. Preferred usually only comes into play when a startup has a bad ending. Founders will also act in their own self-interest, and they typically own Common shares too.

You can find what type of shares are being issued in the 'Deal Terms' section, or in the company's Form C. You can also see how much a company owes its preferred shareholders to understand where 'in line' you stand.

For example Aptera Motors discloses that $9M needs to be paid to Preferred Shareholders before any money can be given to Common Shareholders. Using this info, you can understand that the exit event would need to far surpass $9M for Common Shareholders to see a meaningful return.

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