If you've received equity compensation, you likely own a piece of your company. But are you clear on what kind of shares you have? This article breaks down the crucial differences between common and preferred stock, as well as various share classes, helping you make the most of your equity award.
Understanding Equity Compensation: A Quick Recap
Before we get into the specifics of share types, let's briefly recap what equity compensation is. In short, it's a way for companies to reward and incentivize employees by giving them ownership in the company through shares of stock. This aligns employee interests with the long-term success of the company.
The most common forms of equity compensation include:
Stock Options: The right to purchase shares at a predetermined price (the strike price) within a specific timeframe.
Restricted Stock Units (RSUs): Shares of company stock granted to employees that vest over time.
Employee Stock Purchase Plans (ESPPs): Allows employees to purchase company stock at a discounted rate.
Stock Appreciation Rights (SARs): Provides a cash payment equivalent to the increase in the value of a share over a specific time.
Within these broad categories, you'll encounter different types of shares, which carry different rights and obligations.
The Two Main Types of Shares: Common Stock and Preferred Stock
The most fundamental distinction lies between Common Stock and Preferred Stock. Here's a breakdown:
1. Common Stock:
What it is: The most basic form of ownership in a company. When people refer to "stock" in general, they usually mean common stock.
Voting Rights: Typically carries voting rights, allowing you to participate in company decisions (e.g., electing board members, approving mergers). The number of votes you have usually corresponds to the number of shares you own.
Dividends: Common stockholders are entitled to dividends if the company declares them, but they're the last in line to receive them after preferred shareholders.
Liquidation: In case of company liquidation, common stockholders receive proceeds after all creditors and preferred stockholders have been paid. This means that they bear the most risk but also have the potential for the greatest reward.
Example:
You receive 100 shares of common stock when your RSUs vest. You have a say in shareholder votes at the annual meeting. If the company declares a dividend, you'll receive a payment (though it might be less than a preferred shareholder). If the company goes bankrupt, you'll only receive money after all other claimants have been satisfied.
2. Preferred Stock:
What it is: A type of stock that has certain preferential rights over common stock. Think of it as a hybrid between debt and equity.
Voting Rights: Usually does NOT carry voting rights, or if they do, the voting power is typically limited.
Dividends: Preferred stockholders have a higher claim to dividends. They get paid out first before common stockholders. Often, these dividends are fixed, making preferred stock a more predictable source of income (though they generally will not grow as fast as common stocks).
Liquidation: Preferred stockholders have a higher claim to assets in a liquidation scenario. They get paid out before common stockholders, but after creditors.
Conversion Rights: Preferred stock sometimes carries the right to convert into common stock under certain conditions. This is often the case with preferred shares issued to investors during funding rounds.
Example:
Early investors in a tech startup might receive preferred stock, which provides them with more security in the event of a downturn and first access to dividends. In exchange, they might have limited voting power.
Key Differences Summarized:
| Feature | Common Stock | Preferred Stock |
| Voting Rights | Typically YES | Typically NO |
| Dividend Priority | Lower | Higher |
| Liquidation | Lower priority | Higher priority |
| Risk/Reward | Higher risk, higher potential reward | Lower risk, potentially lower reward |
Types of Common Stock & Share Classes
While the primary distinction is between common and preferred stock, companies can further categorize their common stock into different "classes." The most common is Class A and Class B.
Class A Stock: Typically offers one vote per share. This is often the common stock issued to the public, and that you will generally receive in your equity package.
Class B Stock: Often has super voting rights. It might offer ten votes per share or even more. These are often held by founders, executives, and other insiders to maintain control over the company.
Example:
A tech company's founder might retain Class B stock with 10 votes per share while the public and employees receive Class A stock with only one vote per share. Even though the founder may own a smaller percentage of the total shares, their Class B stock gives them disproportionate voting power.
Why do this? To allow the founders to retain control of the company.
Employee Perspective: As an employee with Class A stock, you should be aware of the voting power structure to understand the level of influence you have.
Understanding Share Types in Your Equity Package
When you receive your equity award grant, pay close attention to the documentation. It should clearly specify:
The type of equity: Stock options, RSUs, ESPP, or SARs.
The type of shares: Common stock, preferred stock, or a specific class of common stock (e.g., Class A common stock).
Vesting Schedule: When your shares will become fully yours.
Exercise Price (for stock options): The price at which you can purchase shares.
Terms and Conditions: Any other restrictions or stipulations associated with your award.
Key Questions to Ask:
What type of stock am I receiving? Common, preferred, or a class of common?
What are the voting rights associated with my shares?
What is the vesting schedule?
Are there any other restrictions on my shares?
How does the company handle dividends?
Understanding share types within your equity compensation is essential for making informed decisions about your finances. By knowing the differences between common and preferred stock, as well as the potential for different classes of common stock, you can gain a deeper understanding of the value, rights, and potential risks associated with your equity award. Always refer to your grant documentation and don't hesitate to ask your HR or benefits team for clarification. Armed with this knowledge, you can navigate your equity compensation package with confidence and work towards your financial goals.