Confused between common stock vs preferred stock? This is a common thought among those starting their investment journey. While common stock is typically granted to founders and employees, preferred stock is usually offered to investors and includes special benefits such as convertibility. Let’s take a look at each of them.
Key Takeaways
- Common stock offers basic ownership and voting rights but comes with higher risk.
- Preferred stock gives investors priority in liquidation and often includes conversion rights.
- Founders and employees usually receive common stock, while investors are granted preferred stock.
- Preferred stock provides more security and financial protection, especially during liquidity events.
What is Common Stock?
Common stock represents fractional ownership in a company. It often comes as restricted stock or stock options under an equity incentive plan, allowing employees to buy shares at a set strike price.
Common shareholders usually have voting rights on major company matters. However, they are last in line during liquidation, making common stock riskier. Despite this, it offers higher potential upside if the company grows or exits at a strong valuation.
What is Preferred Stock?
Preferred stock is typically issued to investors during funding rounds and includes special rights not granted to common shareholders. These often include liquidation preference, dividend rights, and conversion options to common stock.
Its terms are usually negotiated and may feature protective provisions, redemption rights, and anti-dilution protections, giving investors more security and influence. As a result, preferred stock is generally less risky than common stock.
Common Stock Vs. Preferred Stock: Understanding Key Differences
| Feature | Common Stock | Preferred Stock |
| Ownership | Basic ownership | Ownership with special rights |
| Recipients | Founders and employees | Investors during funding rounds |
| Price | Sold at fair market value | Priced higher due to negotiated valuation |
| Voting Rights | Standard voting rights | May have enhanced or limited rights |
| Convertibility | Usually non-convertible | Often convertible into common stock |
| Liquidity | Illiquid, sold during events or privately | Illiquid but may have buyback options |
| Liquidation Payout | Paid after creditors and preferred holders | Paid before common stockholders |
| Risk | Higher risk | Lower risk |
Conclusion
Whether you're a founder, employee, or investor, knowing the distinction between common and preferred stock is vital when evaluating equity ownership in a company. Common stock carries more risk but higher potential reward, whereas preferred stock offers greater protection and priority during exits or liquidation. Both play important roles in a company’s capital structure, and choosing the right type depends on your goals and risk tolerance.