Convertible preferred shares are a special class of company shares that give investors priority rights over ordinary shareholders but can be converted into ordinary shares under specific conditions, typically during a successful exit or IPO.
Convertible preferred shares are hybrid securities that combine features of both debt and equity.
They sit above ordinary shares in the company's capital structure, meaning preferred shareholders get paid first if the company is liquidated.
The "convertible" aspect means these shares can transform into ordinary shares when certain triggers occur, such as an IPO or acquisition.
When investors buy convertible preferred shares, they receive special rights like anti-dilution protection and board representation.
If your company does well, they can convert their preferred shares into ordinary shares to participate in the upside.
If things go poorly, they keep their preferred status and get paid before ordinary shareholders during any liquidation.
Convertible preferred shares offer investors downside protection whilst maintaining upside potential.
They provide preferential treatment during distributions and often include protective provisions that give investors some control over major company decisions.
This structure helps reduce investment risk compared to buying ordinary shares directly.
Convertible preferred shares typically convert automatically during qualified IPOs (usually when the company raises above a certain threshold) or successful acquisitions.
Investors may also choose to convert voluntarily if they believe the ordinary shares are worth more than their preferred position, though this rarely happens before an exit event.
Convertible preferred shares usually include liquidation preferences (getting money back first), anti-dilution protection (maintaining ownership percentage), voting rights on major decisions, and information rights.
Some may also carry dividend rights, though early-stage companies rarely pay dividends to preserve cash for growth.
Convertible preferred shares can be beneficial for founders as they attract investment whilst allowing you to retain control through ordinary shares.
However, they do create a hierarchy where investors get preferential treatment.
The key is negotiating terms that protect both investor interests and founder equity in successful outcomes.
