I have invested in several companies so far through equity crowdfunding rules (on sites like seedinvest and wefunder), but I'm still not totally clear on how future equity might be allocated. Does anyone know the math/legal implications of owning preferred stock? How is it decided how much equity you may be entitled to if, say, there is an IPO or a sale of the company?
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1oh boy. if you must do the new Reg-A "invest in startups!" thing ... startengine.com is a highly regulated, by-the-book, thing with reasonably serious vetting, checking, investigation, etc of the (reasonably legitimate, reasonable, non-"nutso") "startups". I would take great care with any of the not-so-serious websites with "startup" listings.– FattieDec 24, 2020 at 18:42
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5"but I'm still not totally clear on how future equity might be allocated." Uh oh. "How is it decided how much equity you may be entitled to if, say, there is an IPO or a sale of the company?" You're supposed to this due diligence before investing your money, not after.– RonJohnDec 24, 2020 at 18:46
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1 Answer
The most likely answer is you are entitled to nothing, but it totally depends on the documentation on the preferred stock and the terms.
You are clearly an owner of preferred stock, correct? Preferred stock is not common stock. Common stock is what is generally purchased in the sale of a company or an IPO, not preferred stock. There is the possibility you're preferred stock does have some rights to common stock in the future, but you'd need to check the documentation. You have the right to a structured cash flow payment from the company, similar to debt except there's generally more upside with preferred but also more leeway in not paying the cash flow. You gotta check the documentation.
Similar to debt, preferred stock is not really going to be affected directly by the purchase of a company. However, debt commonly has provisions that it can mature upon a change of control if the debtholder chooses to do so. You're preferred may have something similar. A new owner of the company often may try to recapitalize the company and force the current debt/preferred out of the company to put their preferred capital structure in place, so you may get squeezed out with some sort of prepayment or whatever is allowed in the preferred stock documentation. Or they may just offer you $X for the preferred upon the purchase of the common stock. It will not necessarily be the same to the price they pay for the common stock.
Seriously, read the agreement for the preferred stock, it should be all in there. Like debt and unlike common stock, preferred stock always has custom terms involved that will be defined upfront.
