Recently, we talked a little bit about the different types of equity offerings you might run into as an angel investor.
Still, I’ve been getting a lot of questions from angel investors who want to know the difference between common and preferred stock.
See, when you invest in a startup, you’re basically signing onto a contract that entitles you to shares of that company once a “trigger event” occurs. (For more on that, click here.)
Once that happens, your investment converts into either common or preferred stock.
While both types of shares make you a part owner of that startup, there are some important functional differences between the two that you should know.
Common stock is usually held by the founders of a company, while investors tend to get preferred stock. The biggest difference between the two is that, come time to make an exit, preferred stockholders get their fair share of the money first. Those with common stock have to wait.
When that exit is a huge acquisition or IPO, the distinction is much less important. But suppose that a startup you invest in sells for less than it was worth when you got in.
In that case, preferred shareholders would get their money back first. Common shareholders would only get theirs if there was still any capital left. Sometimes, by the time preferred stockholders get their money back, the pot is already empty.
This is a pretty common scenario, especially for angel investors with less experience. That’s why I always recommend following the guidance of an experienced angel when you’re first starting out. Investing with recommendations from a seasoned pro is one of the best ways to reduce your chance of failure – and learn to choose better deals that boost your bottom line.
It’s not always easy to find a qualified angel investor with a proven track record. That’s why I created the Angels & Entrepreneurs Network. It’s a platform that hosts thousands of angel investors, startup founders, entrepreneurs, and educators – not to mention dozens of informational resources to help you get started. Just click here to learn more about the Angels & Entrepreneurs Network.
Do you have a question about angel investing you’d like to see answered? Leave a comment below! I’m always open to requests for new content.
And, if you’d like to learn more about common and preferred stock, just check out the video above.
Until next time,