The role of share classes in VC investing
Funding of startups can take many forms, but fundraising is commonly conducted via shares issuance – either common or preferred. While common shares are usually held by founders & employees or early investors, preferred shares are owned by large institutional investors. Thus, it is not surprising to see the capital structure of late-stage companies to be dominated by preferred shares.
Both types of shares offer investors partial ownership of a company and preferred shares are usually converted to common stocks at some liquidity event (e.g. IPO), but until then preferred shareholders utilize certain privileges. The most common benefits are:
- Liquidation preferences. If a company undergoes a liquidation/liquidity event, preferred shareholders are paid before holders of common stocks. There might be a case when common shareholders are not paid at all, as the full amount of proceeds is distributed to preferred shareholders.
- Anti-dilution protection. Preferred investors get special options to be protected from future dilution of their percentage holding in a company. For example, pro-rata rights—which give the investor the right to invest in future rounds to maintain their shareholding percentage.
The recent acquisition of Gorillas by Getir in an all-stock deal at a $1.2B valuation is a prime example of benefits utilized by preferred shareholders. During the most recent round in September 2021 Gorillas was valued at $3B, the company raised $1.3B since inception in the mix of common and preferred stocks.
Transaction terms imply that current Gorillas investors exchange shares held to Getir stocks. But since the $1.2B valuation is less than $1.3B raised in total, that was the case for preferred shareholders only, who accelerated liquidation preferences provision and received their full nominal investment amount in Getir shares. Common shareholders lost almost all funds invested.
Gorillas case highlights that it is crucial to understand what class of share you invest in and what rights and privileges are accomplished.