As a founder, you're likely to hear investors talking about "ordinary shares" and "preference shares". These represent more than just stock options: they embody different rights, privileges, and obligations that could impact the long-term future of your business. That’s why understanding the distinctions between these types of shares is so important for structuring your business and negotiating with VCs.

Shares are units of equity ownership in a business and come in various types, each of which entitles the owner to different rights and privileges.

Ordinary shares are the foundational class of stock in most companies. Often issued to founders, employees, and early investors, holders of ordinary shares typically have equal voting rights. That means they can influence major company decisions, including electing Board members, working on mergers, and weighing in on any changes to the company's constitution.

Key features of ordinary shares:

• Voting rights: Shareholders have equal voting power per share owned.
• Dividends: If the company decides to distribute profits, ordinary shareholders will receive dividends, although they are typically the last in line after other financial obligations including creditors.
• Exit distribution: Upon an exit event (e.g., sale or IPO), ordinary shareholders are entitled to a proportion of the remaining proceeds after other higher-priority shareholders (like preferred) have been paid.

As an early-stage founder, you’ll likely issue ordinary shares to yourself and your co-founders. These shares can also attract employees, especially under employee stock option schemes.

When VCs and institutional investors come on board, you’ll often encounter preference shares.

Preference shares differ significantly from ordinary shares, especially in the way they offer downside protection and exit privileges to investors.

These shares “rank ahead” of ordinary shares when it comes to payouts, offering the investor more control over the outcome in both liquidation and exit scenarios.

Key features of preference shares:

• Liquidation preference: Investors holding preference shares get paid back before ordinary shareholders during an exit or wind-up event. This typically means they’ll get their initial investment back (or more, depending on the liquidation multiple) before the ordinary shareholders see any returns.
• Anti-dilution rights: Preference shareholders often have protection from future rounds of funding that could dilute their ownership percentage. This is particularly valuable in down rounds when the company's valuation decreases.
• Voting rights: Preference shareholders may not always have voting rights in public companies, but in private companies (like most early-stage startups), they often negotiate similar rights to ordinary shareholders. They can also secure the right to appoint members to your Board, enabling them to influence key decisions.
• Dividend priority: In some cases, preference shareholders get paid dividends before ordinary shareholders, although dividends are rare in early-stage startups focused on growth.

In 2024, 84% of term sheets issued in the UK included preference shares, in line with 81% in 2023¹. VCs, especially at Series A and beyond, typically insist on preference shares to protect their investments, especially when the company is in its high-growth phase, because this phase of a business’s growth carries significant risk.

It’s also worth noting that different investors view preference shares differently.

89% of VCs in 2024 invested using preference shares, compared to 37% of angels (although this is up significantly from 12% in 2023)². This reflects the fact that VCs take on higher risks by investing significant amounts and emphasises their need to make downside protection a priority. VCs are also investing on behalf of LPs, whereas angels are investing their own capital.

When negotiating with VCs, preference shares are almost inevitable. However, it’s essential to understand the long-term implications these shares can have on your business. For example, preference shares with heavy liquidation preferences or anti-dilution clauses could limit the amount of return you and your team receive during an exit.

Key negotiation points to consider:

Liquidation preferences: Preference shares often come with liquidation preferences, which could give the investor the first cut of proceeds during an exit. As a founder, aim to limit the liquidation multiple to 1.0x, ensuring that investors only receive their initial investment back before others share in the exit proceeds. We’ve discussed this in detail in our blog on liquidation shares.

Control rights: Negotiate for a balanced level of control in your company. VCs may ask for Board seats or veto rights on major decisions, but as a founder, you should retain enough autonomy to steer your business.

Future rounds: When giving preference shares in early rounds, consider how these terms may evolve in future rounds. Series A investors may demand similar terms as future Series B investors, creating a complex hierarchy that can dilute founder influence.

Voting rights: Ensure you’re not giving away too much control. While VCs often want some say, they shouldn’t have the power to override your vision for the company.

By understanding and negotiating these terms early, you can structure your business in a way that attracts investment without compromising the future returns or control for you and your team.