Note: This post is the first of a two-part series on the topic of Share Capital & Design.
Shares = equity = ownership. True, but this is really just the beginning. Even at start-up, it’s worthwhile for Founders (especially if this is their first venture) to get a good understanding of what their shares can and cannot do, what rights and restrictions attach to each share and how changes can be made to their shares down the road.
Share Capital Commons & Prefs.
*At the start. Commonly startups begin with a single class of shares designated as “common shares” which have certain fundamental rights attached including the right to vote, the right to receive dividends (if issued) and the right to receive the remaining property of the corporation on dissolution.
*Founders’ benefit. Founders’ typically are issued common shares at the time of incorporation since they are seen to be the residual risk takers in the business and entitled to share in the corporation’s financial rewards.
*But what about Prefs? Preference shares (Preferreds, Prefs) are sometimes issued at the time of startup and typically do not attach the right to vote, but have a preferential right to receive dividends before dividends are paid on the other classes of shares and/or a first priority to receive their initial contribution for their shares back before the remaining (i.e. common shareholders) in the event of an acquisition/exit.
>Do without? Issuing common shares alone at the time of startup may be more desirable than also issuing a set of Prefs, since the single share class provides a simpler, less onerous option for the Company (no dividend requirements or priority repayment of capital required).
>But my investor wants them. If so, Prefs may be included in your company’s capital structure at startup. Keep in mind that the attributes of preference shares are widely variable so there is ample room to design a preference share class that fits both Founder and investor needs. However, with flexibility comes added complexity, so be sure to understand how the Prefs work with the commons and that they’re not so overly complex that future investors will be turned off.
Check back soon for our next post on designing your shares – Commons, Prefs, whatever the case may be!