What’s the Difference Between Common and Preferred Stock?
One of the most common questions startup founders ask—especially before raising capital—is what the real difference is between Common Stock and Preferred Stock. The question usually comes with a follow-up: if common stock is simpler, why can’t startups just sell common stock to investors?
This distinction matters more than many founders realize. The way equity is structured affects taxes, fundraising, control, and exit outcomes. Getting it wrong early can create problems that only show up later—often at the worst possible time, such as during a priced round or acquisition.
This article explains the difference between common and preferred stock, and why issuing common stock to investors is usually a mistake for early-stage companies.
What Is Common Stock?
Common Stock represents basic ownership in a company. It is typically issued to the people building the business: founders, employees, and sometimes advisors.
Common stockholders usually have voting rights and share in the upside if the company succeeds. However, they are last in line when it comes to payouts. In a sale or liquidation, common stock only receives value after all creditors and preferred stockholders have been paid. Because common stock carries the most risk and the least protection, it is intentionally used for those who are betting on long-term growth rather than contractual safeguards.
What Is Preferred Stock?
Preferred Stock is a separate class of equity, almost always issued to investors. It's "Preferred" because it has preferences over Common Stock, including additional rights such as "liquidation preference" and "protective provisions" designed to protect against downside risk and provide clarity around control and economics.
Preferred stock is not about taking value away from founders. It is about allocating risk in a way that matches how startups actually operate and fail. Most venture-backed companies issue preferred stock in priced financing rounds because it creates predictability for both investors and founders.
Key Differences Between Common and Preferred Stock
Here is a high-level comparison that founders should understand before issuing any equity:
FeatureCommon StockPreferred StockTypical holdersFounders, employeesInvestorsLiquidation priorityLastFirstDownside protectionNoneYesAnti-dilutionNoOften yesProtective provisionsNoYes
This difference in rights is exactly why startups should be careful about who receives which class of stock.
Why Startups Shouldn’t Sell Common Stock to Investors
Selling common stock to investors can seem appealing at first. It feels simpler, more founder-friendly, and less intimidating than negotiating preferred terms. In practice, however, it often creates serious downstream issues.
1. It Can Create Tax and 409A Problems
When a company sells common stock at a meaningful price, it establishes an implied market value for common stock. That valuation can impact 409A valuations and create tax exposure for founders and employees who received common stock at a lower price.
This is one of the most common ways founders accidentally trigger unexpected tax consequences for themselves and their team.
2. It Creates Red Flags for Future Investors
Professional investors expect a clean and familiar capital structure. Founders and employees hold common stock. Investors hold preferred stock.
When early investors hold common stock, later-stage investors often require the company to restructure the cap table before investing. These restructurings are time-consuming, expensive, and sometimes derail financings altogether.
3. Governance Becomes Unclear and Exits Becomes Tricker
Common stockholders often have voting rights but no agreed-upon framework governing their influence. This can lead to confusion or conflict when major decisions arise.
Preferred stock solves this problem by clearly defining control, veto rights, and board representation. Without that structure, governance disputes tend to surface when the company can least afford them.
In acquisitions, buyers want clarity. Preferred stock establishes a clear payout order, making it easier to model outcomes and close deals. When investors hold common stock, that clarity disappears. Ambiguous cap tables increase friction, slow negotiations, and can even reduce deal value.
“What If My Investor Is Willing to Take Common Stock?”
Founders often hear this from friends, family, or early angels. While the intent may be good, intent does not override tax rules or market expectations.
Even if an investor is comfortable with common stock today, future investors, acquirers, and regulators may not be. The structural issues remain, regardless of how friendly the relationship is at the outset.
Better Alternatives to Selling Common Stock to Investors
For early-stage companies, there are cleaner and more market-aligned options:
SAFEs (pre-money or post-money)
Convertible notes
Preferred stock in a priced round once valuation is established
These approaches preserve flexibility, reduce tax risk, and align with investor expectations.
When Is It Appropriate to Issue Common Stock?
Common stock is best used for:
Founders (with vesting)
Employees and advisors
Equity incentive plans
It reflects participation in upside, not negotiated downside protection.
Founder Takeaways
The difference between common and preferred stock is not just technical—it shapes the future of your company.
Common stock is designed for building the business. Preferred stock is designed for financing it. Mixing those roles too early often creates problems that cost far more than they save.
If you are fundraising or planning to, it is worth getting this right from the start.