employee equity compensation in tech startups
July 13, 2021
March 10, 2021
July 13, 2021
March 10, 2021
The preferred share price, or pref price, is what investors paid for one company share during the latest investment round.
The pref price does not directly mean anything for your employee equity, but may be interesting to you as a signal of company success or to help you value your company shares.
If you have stock options and want to get the full picture of how they work, read our Stock Option Starter Guide.
Ask your employer. Note that not every company discloses the pref price to their employees.
The price is the result of a negotiation between the founders of a startup and its latest investors.
When a startup raises money during an investment round, the investors that provide this sum of money get company shares in return.
But how many do they get? The larger the number of shares the investors receive, the more they would earn in case the startup has a successful exit in the future. For the founders, it’s the other way around: the more shares they give away, the less they would make.
Having opposite incentives, founders and investors negotiate and settle on a number of shares. The pref price is the invested amount of money divided by this number.
The pref price does not directly affect your employee equity or the profit you’ll make off it.
Still, it may be of interest as a proxy signal of company success. The idea is that if the pref price increases at each new investment round, investors believe the company is moving in the right direction.
That’s a good sign, and given the uncertain nature of employee equity, any sign is welcome. Just keep in mind that venture capitalists have no crystal ball either, and investor-lauded companies have failed in the past.
Other ways in which the pref price may be relevant to you:
Legally, a startup has two types of shares: common and preferred. Employees are typically given common shares, while investors are typically given preferred.
This means that technically, the price that investors pay per share only refers to the preferred company shares. Nevertheless, as the pref price is indicative of the company as a whole, it is commonly used as a baseline valuation for both types of shares.
Think of preferred shares as supershares that come with legal benefits. If your company is acquired (or goes bankrupt), preferred shareholders get paid first. Depending on what is negotiated, they may have additional rights such as getting paid back twice their investment before anyone else gets paid.
With these benefits, preferred shares are technically worth more than common shares. This is why the 409a valuation of your common shares is generally lower than the pref price.
Still, the hope for startups is that the legal benefits of the preferred shares will one day be obsolete. Venture capitalists negotiate the benefits as protection for when a startup they invest in does not perform as they had hoped. If the startup in fact succeeds, their benefits generally do not materialize and both common and preferred shareholders receive the same payout per owned share.