You can provide many types of securities to investors in exchange for capital. Two of the most common securities are common stock and preferred stock, and you need to know the differences between these two types of securities.
- Common Stock
Common stock indicates shares that are in a corporation and that have no preferences or priorities over other classes of stock. The rights to distributions, number of votes per share, liquidation rights, and other rights are the same for all shareholders and on a share-by-share basis.
- Preferred stock. Preferred stock is comprised of shares that give the holders various benefits over the common stock holders. Many professional investors, including venture capitalists, prefer preferred stock to common stock.
Preferred stock often offers the following rights:
- A priority on the business’s assets upon liquidation
- A priority on any dividends
- Special voting or veto rights
- The right to force the company to buy back the shares at some point in the future — known as redemption rights
- The right to convert to common stock based on a formula
- Protection against certain stock splits, stock dividends, and future cheap issuances of stock — known as anti-dilution rights
- A possible separate right to elect a designated number of directors
In issuing shares to its initial shareholders, the corporation must ensure that it complies with both state and federal securities laws. These laws apply whenever you issue “security,” such as common or preferred stock. Typically, the issuance of shares to a small number of founding shareholders qualifies for a “private placement” type of exception from the registration requirements of securities laws. But double-check with your lawyer before you proceed.
Keeping a stock ledger
The company must keep good records of stock issuances, showing the amount of stock issued, dates issued, and funds received. A stock ledger can help the company organize this information. Keeping copies of all issued stock certificates is generally a good idea, at least while the company is privately held.