When investing in startups, particularly through Regulation Crowdfunding (Reg CF) or Regulation A+ (Reg A+), understanding the type of equity you receive is crucial. Companies primarily raise capital through equity, debt, or hybrid securities like SAFEs and Convertible Notes.

This article focuses on the two main types of equity: Common Stock and Preferred Stock.

Common Stock: The Basic Building Block

Common Stock represents the most basic form of ownership in a company. Key characteristics usually include:

  • Voting Rights: Typically, each share grants one vote in major company decisions (like electing directors), though variations like non-voting common stock exist. Since most investors in Reg CF and Reg A+ are writing smaller checks on average, those shares usually delegate voting rights to either a lead investor or the CEO.

  • Dividend Potential: Common stockholders may receive dividends, but only if declared by the Board of Directors, and usually after any Preferred Stock dividend obligations are met. Dividends are rare in early-stage startups, as profits are typically reinvested for growth.

  • Liquidation Priority: Common stockholders are last in line to receive any remaining company assets if the business liquidates or is sold. This means lenders, creditors, Preferred stockholders, and sometimes even SAFEs get paid back first.

  • Upside Potential: Holders share in the company’s growth potential without caps (unlike some debt or preferred structures).

Who Holds Common Stock?

Founders, employees (through stock options), and sometimes very early “friends and family” investors typically hold Common Stock. In the Reg CF/Reg A+ space, you will see offerings for Common Stock, often because it’s simpler for the company to issue.

The Downside of Common Stock for Investors

Being at the bottom of the “capital stack” (the hierarchy of capital claims) means Common Stock offers the least downside protection. It also generally lacks the special rights and preferences granted to Preferred stockholders. However, if all of a company’s shares are issued via Common and there are no Preferred shares, then all Common shareholders — employees and investors — may be treated the same in terms of the capital stack.

Preferred Stock: Adding Investor Protections

Preferred Stock is a class of equity designed to offer investors additional rights and protections compared to Common Stock. While common in traditional Venture Capital (VC) deals, it also appears in some Reg CF and Reg A+ offerings.

Its name comes from the “preferences” it grants holders, most notably:

  • Liquidation Preference: This is a core feature. In a sale or liquidation event, Preferred stockholders are entitled to receive their initial investment back (or sometimes a multiple, like 1.5x or 2x) before Common stockholders receive anything.

    • Non-Participating (“Straight”) Preferred: This is most common. The investor chooses either to receive their fixed liquidation preference amount or to convert their shares to Common Stock and share in the proceeds proportionally alongside other Common stockholders. They choose whichever option yields a higher return.

    • Participating Preferred: Less common today and less founder-friendly. Investors receive their liquidation preference and also share proportionally (as if they owned Common Stock) in any remaining proceeds. Sometimes this participation is capped.

  • Dividend Preference: If dividends are declared, Preferred stockholders often receive their dividends before Common stockholders. Dividends might also be cumulative, meaning any missed payments accrue. (Again, dividends are rare early on).

  • Other Potential Rights: Preferred Stock often comes bundled with other protective provisions or rights, such as:

    • Anti-Dilution Protection: Adjusts the conversion price if the company later issues stock at a lower valuation, protecting investors from significant dilution.

    • Pro-Rata Rights: The right (but not obligation) to invest in future funding rounds to maintain their ownership percentage.

    • Information Rights: The right to receive regular financial updates from the company.

    • Protective Provisions: Voting rights on specific major corporate actions (like selling the company or issuing stock senior to theirs), even if they don’t have general voting rights.

Liquidation Preferences

Liquidation preferences often come with a multiple of an investor’s investment as a preference. This is normally “1x” meaning investors will be paid back the full amount of their investment before any other equity holders, but can be 2x or even 3x. Investors may also ask for their preference plus the common interest meaning the investor will be paid their preference and will also share in any additional proceeds in proportion to their equity stake. Founders should be wary of the liquidation preferences they agree to with one investor as that will set what all future investors want because no investor will want other investors in the cap table with a preferred position to themselves. Needless to say, liquidation preferences, especially participating preferred liquidation preferences, are not very founder-friendly. 

Non-Participating Liquidation

Non-participating liquidation preferences, or “straight preferences,” are the most commonly used. If an investors’ preferred stock contains these preferences, the investor can choose to  either (1) receive their liquidation preference or (2) share in the proceeds in proportion to their equity stake after converting their shares into common stock. 

Capped Liquidation

Capped liquidation preferences are sometimes referred to as “partially participating preferred” and are equally favorable to investors and companies. If an investor’s preferred stock contains a capped liquidation preference, the investor will be paid back their preference and then will share in any additional proceeds in proportion to their equity stake. As the name implies, however, an investor’s returns will be capped. 

The liquidation preferences that come with preferred stock provide early investors a number of rights and privileges like a right to a board seat, information rights, a right to participate in future rounds to protect their ownership percentage (pro-rata right), a right to purchase any common stock that might come into the market (right of first refusal), a right to participate alongside any common stock that might get sold (co-sale right), and an adjustment in the purchase price to reflect sales of stock at lower prices (anti-dilution rights). 

Preferred stock has many variations. Some of which may not be founder-friendly. Entrepreneurs should seek to educate themselves as to which option is best for them. Investors should also be wary of being too greedy when submitting term sheets. You want to ensure entrepreneurs now and in the future view you as a fair investor. An entrepreneur’s best option may be to have multiple investors at the table to leverage them against each other. Preferred stock can be a win/win for everyone.

Why It Matters for Reg CF / Reg A+ Investors

When evaluating an investment crowdfunding opportunity, the type of security offered is a key factor:

Feature Common Stock Preferred Stock What It Means for You (Reg CF/A+ Investor)
Liquidation Paid last Paid first (up to preference amount) Preferred offers better downside protection if the exit value is low.
Upside Unlimited potential Potential depends on structure (see above) Common has direct unlimited upside; Preferred upside depends on participation/conversion features.
Investor Rights Basic voting (not common in Reg CF, though) Liquidation Preference, Anti-dilution, etc. Preferred typically offers more contractual protections and potential influence/information.
Complexity Simpler More complex terms Common is easier to understand; Preferred requires careful review of specific terms (check the Form C!).
Typical Issuance Founders, Employees, some Reg CF VCs, Angels, some Reg CF/A+ Deals offering Preferred may signal more alignment with traditional venture terms, but always check details.

Making Informed Decisions with Kingscrowd

While Preferred Stock generally offers more downside protection, companies may offer Common Stock in Reg CF rounds for simplicity. Neither is inherently “better” – it depends on the specific terms, the company’s stage, the valuation, and your personal risk tolerance.

Many Reg CF deals also utilize SAFEs or Convertible Notes, which convert into equity (often Preferred Stock, but sometimes Common) upon a future financing round or event. Understanding the underlying equity class these instruments target is therefore essential.

At Kingscrowd, we empower you to navigate these complexities. Our platform aggregates deals and provides research, ratings, and analytics, allowing you to understand the securities offered in each deal. By filtering and analyzing investment opportunities, you can make more informed decisions aligned with your investment strategy.

Interested in leveraging data-driven insights for your startup investments? Explore Kingscrowd’s ratings and analytics by creating your free account today.