Is Preferred Equity the “Preferred” Structure of Equity Crowdfunding?

Investors participating in equity crowdfunding markets have the opportunity to invest in preferred equity, most often seen on SeedInvest.

Preferred Equity provides an ownership stake to investors, like common equity, however, it has certain advantages over traditional common stock. For this reason, many angel investors and venture capitalists prefer to invest in preferred stock as opposed to common.

Preferred holders have ownership rights and receive preference to common stakeholders.

Advantages of Preferred Equity over Common Equity

As we just mentioned, preferred stock entitles investors to certain additional rights on top of the rights received by common stakeholders while providing capital for the business to grow. However, preferred investors receive preferential treatment with respect to certain aspects of the business. These include:

• • Liquidation Preference: The most important benefit of being a preferred equity holder is the preference should a business-liquidation event occur. Obviously this is not an ideal situation for a startup to find itself in – but it does happen.

    
    It goes without saying that early-stage companies seeking equity crowdfunding are risky ventures, with a high probability of failure. Therefore, protecting investment becomes critical for investors weary of their invested company failing.

    
    Thus, if the business shuts down and is sold, proceeds of the sale will first be given to preferred equity holders, before the money is distributed among the common stockholders.

• • Dividend Preference: Similarly, at the time of payment of dividends out of the company’s profits, first preference is given to preferred stockholders. Common holders receive the remaining dividend payments following preferred stockholders.

     

• • Pre-emptive Rights: Preferred equity holders also receive pre-emptive rights. These rights give them the option to invest in future rounds of financing to prevent dilution of their stake.

     

Bottom Line

Preferred equity provides the cushion of preferential treatment in the case of liquidation of a business, which can significantly impact gains and losses. Based on how the preferred shares are structured, it can also help you to minimize dilution in the future with follow on investing and dividend payments (though this is less likely in early stage ventures).

If you can find companies offering this type of equity, we’d generally say this is a positive for investors. As always, investors must exercise caution while investing in early-stage companies. Differing share-class structures do not eliminate associated risks.

For additional information regarding this topic, check out our related article: “What are the Pros and Cons of Preferred Equity Investments”