Key takeaways
- Preferred stock can be used by founders to raise capital while often providing investors with certain downside protections and priority in liquidation scenarios.
- Clean, standard terms and thoughtful negotiation may help balance investor protections with founder upside.
- Regulatory developments and market trends may influence how founders structure equity—prompting founders to seek informed planning and specialized counsel.
Many startup founders focus on raising capital and growing their business, but the structure of that capital, such as the choice between preferred and common stock, can have lasting consequences. Understanding the differences, negotiation dynamics and evolving market practices is important for founders who want to build resilient companies.
Kim Patel, Vice President, Innovation Economy at J.P. Morgan, offers perspective on how founders can navigate stock options.
This article is for informational purposes only and is not intended as legal, tax, accounting or investment advice. Readers should consult their own advisors regarding their specific circumstances.
What is common stock?
Common stock is often a foundational element of startup ownership. It’s typically held by founders and employees, often granting voting rights and the potential for capital appreciation. Common shareholders are typically last in line for dividends and liquidation proceeds, but their upside may be significant if the company succeeds. For startups, common stock is often used in employee equity plans, incentivizing early team members to help build the company.
What is preferred stock?
Preferred stock is a class of equity that can include features that may resemble debt (for example, liquidation, preferences or fixed dividends). Unlike common stock, preferred shares often have limited voting rights but offer holders priority for dividends and liquidation proceeds. Preferred stock may provide for dividends, which can be fixed or variable. Investors—such as venture capitalists and angel investors—are the typical holders, though it may also be offered to employees as part of compensation packages. Companies may issue preferred stock to raise capital while separately negotiating governance rights and without necessarily increasing traditional debt—depending on the terms of the issuance.
Common misconceptions about preferred stock
Many founders focus only on headline valuations, overlooking the potential long-term impact of deal terms. “A $20 million pre-money number with clean 1x non-participating preferred is fundamentally different from a $25 million pre-money with 2x participating preferred,” Patel said. “The second one looks better on paper, but in a moderate exit, the founder might actually take less home.”
Other frequent misconceptions include believing all preferred stock is the same—when each series (A, B, C) can have different rights and liquidation priorities—and underestimating potential dilution from anti-dilution provisions (where applicable). Founders often neglect to model how money flows in various exit scenarios, or how anti-dilution provisions can, in certain cases, reduce ownership in a down round. “It’s important to understand the liquidation waterfall and how money actually flows in different exit scenarios,” Patel said.
Emerging trends and regulatory changes in preferred stock
- Founder preferred stock and enhanced terms: Founder preferred stock has been observed in parts of the market, with enhanced liquidation preferences and special voting rights increasingly negotiated by founders who have demonstrated strong traction or competitive term sheets.
- Shift in early-stage fundraising: Simple Agreements for Future Equity (SAFEs) are widely used in many early-stage financings due to their simplicity, while convertible notes may be less prevalent in some segments.
- Qualified Small Business Stock (QSBS) regulatory updates: Section 1202 changes in 2025 expanded the asset cap for QSBS eligibility from $50 million to $75 million and increased the gain exclusion from $10 million to $15 million, with tiered holding periods for partial exclusions.
- Valuation and tax implications: The gap between preferred and common stock can be important for 409A valuations. Common stock is typically priced below preferred. Depending on 409A valuations, employees may buy in at a meaningful discount to the preferred price. If the gap narrows too much, it can be challenged by the IRS. Tax rules are complex and may change; consult tax advisors regarding eligibility and application to your circumstances.
Key considerations for founders
Alignment and clarity about downside protection are often important when negotiating liquidation terms. Founders may benefit from modeling liquidation scenarios and understanding the impact of board composition and governance. “None of this feels as urgent as economic terms when you're racing to close a round,” Patel said. “But it can significantly influence governance and control outcomes when it matters most.”
Clarity is also key. “What works is clean, standard terms. Where I see founders get into trouble is when they trade away economics to chase a higher headline valuation,” Patel said. Running the math on exit strategies can help founders avoid giving away a significant percentage of their proceeds.
Early-stage deals tend to be founder-friendly, with solid valuations and straightforward terms. In later stages, investors often have more leverage and demand structured terms such as guaranteed returns and senior liquidation preferences. “Series C in particular has become a real filtering point,” Patel said. “It’s where growth must be proven.” Ultimately, a key protection for both sides is building a great company and choosing the right partners.
As startups remain private for longer periods, preferred stock is taking on a more significant role than it was originally designed for. Previously, preferred shares typically converted to common stock at IPO, making their terms largely irrelevant after a public debut. Now, with many startups staying private for 10 or more years, preferred stock terms continue to shape governance and economics over extended timelines.
This shift has brought increased attention to secondary market provisions and liquidity rights. Investors and employees require access to liquidity before an IPO, and the global secondary market reached a new high in 2025. “Transfer restrictions, information rights and rights of first refusal (ROFR) are all evolving because the old framework assumed a much shorter time to exit,” Patel said.
Tips for founders when structuring equity
- Consider modeling downside scenarios: Understand how different priorities of preferred stock can activate and how that impacts you.
- Use appropriately designed cap table tools for multi-class structures: Managing complexity is essential as your company grows.
- Evaluate governance and control implications: Board composition, protective provisions and drag-along rights determine who has control when it matters most.
- Seek legal and financial advice early: Specialized counsel can help founders avoid pitfalls and negotiate market terms.
The bottom line
Preferred stock is a powerful tool for founders to raise capital and attract investors, but its terms carry real consequences for governance, economics and exit outcomes. Understanding the differences between preferred and common stock, modeling exit scenarios and seeking expert advice can help founders make better long-term choices.
Build your future with J.P. Morgan
Whether you’re structuring your first round or preparing for a strategic exit, J.P. Morgan Startup Banking can help you navigate the complexities of equity and capital raising. Connect with us today and visit our Innovation Economy content hub for more insights.
Contributors
Kim Patel
Vice President, Innovation Economy at J.P. Morgan
JPMorgan Chase Bank, N.A. Member FDIC. Visit jpmorgan.com/commercial-banking/legal-disclaimer for disclosures and disclaimers related to this content.
