As a Delaware C corporation, your company has at least one class of stock, Common. Your company charter may provide for other classes of stock as well (this is likely if you have undergone an equity financing). Multiple stock classes can accommodate different voting rights and priorities for a payout of assets or dividends, among other things.
- Preferred Stock versus Common Stock
- Adding Stock Classes: A Usual Pattern
- Multiple Classes of Preferred Stock
- Multiple Classes of Common Stock
Preferred Stock versus Common Stock
There are two categories of stock classes—Common and Preferred. Preferred stock is usually given to investors, and holders of this class of stock have the opportunity of getting paid out first if a liquidation event occurs. Common stock is often given to founders and employees, and in a liquidation event, they get paid out last (which can mean not at all if the funds are not sufficient).
A company can have multiple classes of each type. Multiple classes of common stock are rare (as noted below), but multiple classes of preferred stock are expected, e.g., Series Seed Preferred Stock, Series A Preferred Stock, Series B Preferred Stock, and so on.
Adding Stock Classes: A Usual Pattern
A company will usually start with just one class of stock: Common stock.
When the company takes on its first round of investment, it will create its first class of preferred stock. In this example, let's say it's Series Seed, Preferred Stock. The company now has two classes of stock. There is one class of common and one class of preferred stock.
Fast forward a few years. The company has now undergone Series A and Series B rounds of investment. In doing so, they've created two more classes of preferred stock: Series A Preferred Stock and Series B Preferred Stock. Now the company has four classes of stock. There's one class of common and three classes of preferred stock (Series Seed, Series A, Series B).
Multiple Classes of Preferred Stock
Why have multiple classes of preferred stock? In other words, why do some investors get the stock class Series A and some get the stock class Series B? And still others Series C? Because in a standard seniority structure, the different classes of stock each get different preferences.
Not only does the preferred stock get paid out first in relation to common stock, but different preferred stock classes get different preferences based on their seniority. Series B gets paid out first, then Series A, then common in a standard seniority structure.
When your Series A investor comes along, they are the king of the castle, so to speak. They get the payout first. Why would they allow Series B investors to come along and invest and take their place at the top? Because the company can't survive without further investment, and if the company doesn't survive, then the Series A investor doesn't get any money anyway.
Multiple Classes of Common Stock
Although it's common to have multiple classes of preferred stock, it is unusual to have multiple classes of common stock.
Why would you create the complexity of multiple common stock classes? Typically it's done to maintain control. Let's say you have two Common classes: Common A and Common B. Common B is the stock for the average employee of the company and has one vote per share. Common A is the stock for the founders and may have ten votes per share, as an example. When the founders vote, they have ten times the influence over what happens, even if they have the same shares as the average employee.
So why doesn't everyone do this? This structure gives founders significantly more control than the traditional structure of just one class of common stock with one vote per share. More founder control means less investor control. Because of this, investors will often avoid investing in companies with this structure or require founders to get rid of it before they invest.
- How do I know if I have multiple classes of stock? Take a look at your charter. If it says something like, "The total number of shares of stock which this corporation is authorized to issue is: Ten Million (10,000,000) shares of Common Stock par value $0.0001 per share," then it only has common shares, and you only have one class of stock. You have:
- Classes of Stock: 1
- Classes of Common Stock: 1
- Classes of Preferred Stock: 0
- If you have anything more than this, you have multiple classes of stock. If your charter instead authorized 10,000,000 shares of Common Stock, 10,000 shares of Series A Stock, and 45,000 shares of Series B Stock, then you'd have:
- Classes of Stock: 3
- Classes of Common stock: 1
- Classes of Preferred Stock: 2
- A complete cap table will also illustrate how many stock classes a company has. If you have any questions, give your lawyer a call to double-check with them.
- How can I tell how many shares each investor bought and how much money they invested? Let's say you have Series A stock and are curious about how to tell, based on your paperwork, how many shares each investor bought. If you find your "Series A Stock Purchase Agreement," there should be a page at the end of the document, which is usually an exhibit (Exhibit A, etc.) that is almost always in a handy chart format, listing each investor, the money they put in, and the number of shares they got. Again, if you're not sure, call the lawyer that helped you with these documents.
Sample scenarios are for illustrative purposes only.
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