Shares of stock are units of ownership or equity in a business or firm. Private companies formed as corporations generally issue common stock, and some also issue preferred stock, which offer different benefits to shareholders. In general, common stock is reserved for founders and employees, while preferred stock is given to investors. Learn more about the differences between preferred stock vs. common stock below.
What is common stock?
Common stock is a type of security that represents a fractional equity ownership stake in a company. Common stockholders (or common shareholders) are granted certain rights, such as voting rights on company decisions. These rights depend on the company’s charter or stockholders’ agreements, as well as the corporate law of the company’s state of incorporation.
In a private company, common stock is usually issued to founders and early employees in the form of restricted stock. Employees generally receive stock options pursuant to an equity incentive plan. Stock option grants give employees the right to exercise their options and buy shares of common stock for a set price, called the strike price. Upon exercise, the company will issue the corresponding number of shares of common stock to the employee or founder.
Common shares are typically the last to receive proceeds based on liquidation preference, which means that preferred stockholders and creditors will be paid first during a liquidity event (such as a merger, acquisition or IPO); common stockholders then receive any remaining assets. This lower liquidation priority makes common stock a riskier investment because the chances of receiving returns in an exit are lower. However, if the company appreciates in value or is acquired at a higher valuation, common stock can have a significant financial upside.
What is preferred stock?
Preferred stock is a type of equity ownership that offers expanded rights and liquidation preferences to shareholders. Private companies typically issue preferred stock to investors—including venture capitalists, angel investors, and private equity firms—during a funding round.
The special rights and protections attached to preferred shares give investors a certain level of security, predictability, and flexibility in exchange for their capital. Since preferred shareholders get primary access to company assets during a liquidity event or bankruptcy, preferred stock is considered less risky than common stock.
The terms of preferred stock can vary depending on the negotiated agreement between the company and its investors.
Differences between common stock vs. preferred stock
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| Common stock | Preferred stock |
| Ownership | Represents basic ownership in the company. | Represents ownership with preferential rights. |
| Recipients | Founders and early employees. | Investors, usually during a funding round. |
| Price | Common stock is usually sold at the fair market value, with a higher potential for capital gains. | Preferred stock is usually sold at a higher amount based on a negotiated company valuation and due to the liquidation preference it receives. |
| Voting rights | Common stockholders can typically vote on important company matters, such as who the CEO is. | Preferred stockholders may receive special voting privileges and protections in private companies. |
| Convertibility | Generally can’t be converted into other types of stock. | Typically includes conversion rights to convert into common stock. |
| Liquidity | Illiquid. Can only be sold through private secondary transactions or during liquidity events. | Illiquid, but may include additional redemption or buyback provisions. |
| Liquidation payout | Common stockholders only receive liquidity after preferred stockholders have been paid. | If the company liquidates its assets or goes bankrupt, preferred stockholders are more likely to get their money back than common stockholders. |
| Risk level | Higher risk due to lower liquidation priority. | Lower risk due to liquidation priority over common stock. |
Carta can help your company issue both common and preferred stock to employees and investors with just a few clicks. Plus, we automatically update your cap table and keep it up to date after every transaction. Learn more about Carta cap table management.
