Who’s Looking out for the Little Guy? Delaware Chancery Court – that’s who!

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In venture capital deals, there is a highly standardized corporate structure. A venture backed company has common stock, owned by founders and employees, and preferred stock, owned by the investor VCs. There may be several series or classes of preferred stock, depending on the number of rounds of investment. Each series or class will have specific rights of priority, rate of return etc. Within the standard model, the actual deal terms can vary widely, but market conditions tend to restrict them to a fairly narrow range at any given time.

One of the key features of preferred stock is the “liquidation preference.” Liquidation preference is the amount of money per share of preferred stock. That must be paid before the common stockholders can receive any payment for their stock. This typically matters only if the company is sold, merged or liquidated.

Historically, when a venture-backed company experiences difficulty or misses certain agreed performance targets, the preferred stockholders essentially take control. At that point, they may be less interested in getting a return on their investment as they are in just getting as much of their investment back as they can. If the company ends up in a “fire sale” transaction, the preferred stockholders may assume that the common stockholders will be left with nothing after the preferred liquidation preference is paid.

Please see full article below for more information.

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