What Is Non-participating Preferred Stock?

Non-participating preferred stock is a type of stock that provides certain rights and privileges to its holders. This type of stock is often used in startup fundraising rounds, where investors are looking for ways to protect their investment while also providing some potential for return.

It’s worth noting that founders typically negotiate the terms with investors to ensure that the company's interests are protected. This includes setting the right valuation, determining the terms of the liquidation preference, and deciding on other preferences such as conversion rights and anti-dilution provisions.

In this blog post, we'll take a closer look at non-participating preferred stock, including what it is, how it works, and why it's important for startup founders to understand.

• Non-participating preferred stockholders receive preferential treatment over common stockholders in the event of a company liquidation, with the ability to recoup their investment before common stockholders. This can be attractive to investors who want more security and protection.
• Non-participating preferred stockholders don't share in the upside: Unlike participating preferred stock, non-participating preferred stockholders do not share in the company's profits beyond their preferential rights.
• Non-participating preferred stock can create conflicts: If a company issues non-participating preferred stock, it can create conflicts with common stockholders who may feel that their interests are being disregarded in favor of preferred stockholders.

Non-participating preferred stock is a type of stock that gives its holders a priority over common stockholders in case of a liquidity event. This means that if the company is sold, liquidated, or undergoes an IPO, the holders of non-participating preferred stock will receive their investment back before common stockholders receive any proceeds.

Non-participating preferred stockholders are also entitled to receive dividends at a fixed rate, which is typically higher than the rate paid to common stockholders.

1. Participation in Dividends: Participating preferred stockholders are entitled to receive dividends in addition to their fixed dividend rate. In contrast, non-participating preferred stockholders are only entitled to receive their fixed dividend rate.
2. Participation in Company Profits: Participating preferred stockholders may also be entitled to receive a share of the company's profits in addition to their fixed dividend rate, whereas non-participating preferred stockholders do not participate in the company's profits.
3. Return on Investment: As a result of the above differences, participating preferred stockholders generally have a higher potential return on investment compared to non-participating preferred stockholders.
4. Risk: Participating preferred stockholders also take on more risk than non-participating preferred stockholders since their returns are tied to the company's overall performance.
5. Priority in Liquidation: Both participating and non-participating preferred stockholders have priority over common stockholders in the event of liquidation, but participating preferred stockholders have an even higher priority than non-participating preferred stockholders.
6. Voting Rights: Both types of preferred stock generally do not have voting rights, but in some cases, participating preferred stockholders may have the right to vote alongside common stockholders.
7. Convertibility: Preferred stock can be convertible, meaning it can be exchanged for a specified number of common shares, and this applies to both participating and non-participating preferred stock.

Are you looking for more in-depth information on participating preferred stock? Look no further and read Participating Preferred Stock: What Startup Founders Need to Know

Non-participating preferred stock works by giving its holders certain rights and privileges that are not available to common stockholders. These rights and privileges typically include:

• Priority in the event of a liquidation or sale of the company.
• Fixed-rate dividends that are paid before common stockholders receive any dividends.
• The ability to convert their stock into common stock if certain conditions are met.

Non-participating preferred stockholders are not entitled to participate in any additional proceeds that may be generated by the sale of the company beyond their fixed return and preferred liquidation preference.

This means that if the company is sold for a large profit, the non-participating preferred stockholders will only receive their fixed return and preferred liquidation preference, while common stockholders may receive additional proceeds.

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One example of non-participating preferred stock is the Series A Preferred Stock offered by Uber in its early fundraising rounds. This type of stock provided investors with a 1x liquidation preference, meaning that they would receive their investment back before common stockholders in the event of a liquidation or sale of the company. The Series A Preferred Stock also provided investors with a fixed-rate dividend of 5%, which was paid before common stockholders received any dividends.

Another example of non-participating preferred stock is the Series B Preferred Stock offered by Airbnb in its early fundraising rounds. This type of stock provided investors with a 1x liquidation preference and a fixed-rate dividend of 7.5%, which was paid before common stockholders received any dividends.

According to a report by PitchBook, non-participating preferred stock is the most common type of preferred stock used in venture capital fundraising rounds. In 2020, non-participating preferred stock accounted for 55% of all preferred stock deals, while participating preferred stock accounted for 38% of all preferred stock deals.

Non-participating preferred stock is an important tool for startup founders looking to attract investors and protect their company. By offering non-participating preferred stock, startup founders can provide investors with a higher rate of return while also maintaining control of their company.

Overall, non-participating preferred stock can be an effective way for startup founders to raise capital and attract investors. However, it's important to understand the potential benefits and drawbacks of this type of stock, and to negotiate the terms carefully to ensure that the interests of the company and its stakeholders are protected.