The crowdfunding industry has used a variety of investment instruments over the years. Some platforms suggest that founders sell crowd-specific instruments like the CrowdSAFE, while others push them to sell common stock. Wefunder’s philosophy is that retail investors should invest on the same instruments as professional angels and VCs. There are two core reasons for this:

• 1.    Retail investors should get the same rights and protections as professionals and not be taken advantage of due to lower bargaining power or level of understanding
• 2.    To avoid hassle later, founders raising from their communities should get clean, simple terms that align with their other investors

The frequent use of common stock by some platforms is particularly problematic. Except in rare circumstances, Wefunder does not allow companies to raise with common stock. Institutional investors almost always buy preferred stock rather than common due to the rights and privileges attached. As Wefunder views it, if a VC won’t invest on common stock, Wefunder investors shouldn’t either.

Investor Advantages

The liquidation preference is the most important benefit of preferred stock. The preference is particularly critical for early-stage investments. Rather than the money going to common holders (executives and employees), preferred stockholders get their money back first. Common shareholders are generally the last in line to get any sort of payment back. As Naval Ravikant (CEO of AngelList) said: 

“The [liquidation] preference is there for a very specific reason: Imagine that my company was raising at a pre-money valuation of $9 million. And then you came in and you invested $1 million in the company, so the post-money valuation is $10 million. And now you own 10% of the company. Suppose I try to take the million dollars and say, “Hey, we’re just going to divvy up the million dollars to all the shareholders.” Well, if you didn’t have a preference, I would get $900,000, and you would get $100,000 back. Not what you expected…. The preference is really, really important at the early stages. You’d be a fool to do a seed round buying common stock.”

Preferred stock also typically carries other important privileges. For example, anti-dilution rights can help prevent investments from losing value in case of a down round. Say a company conducts a later round of financing and issues new stock at a lower price; when these rights are included, the investor would receive additional shares for free, avoiding dilution of the value of their investment. 

Other advantages of preferred stock may include:

• Pro rata rights, which allow investors to maintain their ownership stake in a startup as it grows;
• the right to receive the first dividends; and
• certain tax advantages (e.g., most preferred dividends are seen as qualified dividends which are taxed at same rates as the capital gains rate). 

Company Advantages

Companies raising on preferred stock also benefit in certain ways. 

First, companies that offer preferred stock are likely to see increased investor interest based on the advantages described in the section above. Also, if sophisticated angel investors expect to invest in preferred stock, then founders offering common stock will foreclose on the ability to raise any capital from those investors. 

Second, raising on preferred stock (as opposed to common) also helps safeguard the value of employee stock options, which can help attract and retain employees. Employees stock options are options to purchase common stock, with the exercise price set at the fair market value of the common stock, as determined by an independent appraisal firm. Generally, when a company raises on preferred stock, the common stock (and therefore the exercise price on employee options) will be valued at a substantial discount—typically 20% to 40% of the preferred stock price—because it’s inferior to the preferred stock in a variety of ways (liquidation preference, antidilution, etc.). This means that employees get the benefit of buying their options for much cheaper, and therefore get a much better return when the company exits. However, if the company instead raises on common stock, the fair market value of the common stock may not be discounted at all, which means that employees could be forced to pay 3x to 5x as much to exercise their options. This makes it very expensive and difficult for employees to exercise and significantly reduces on the return they can receive when the company exits. With equity being a major factor in compensation packages, this can seriously hurt employee retention and the ability to attract top talent.

Conclusion 

Companies raising priced rounds should offer preferred stock to their investors. Retail investors – the true fans, customers, and early adopters – deserve the same protections as professional investors if their favorite company fails. If the goal is to bring the community along for the ride, they shouldn’t be given inferior terms to institutional investors. Further, down the line offering common stock can end up hurting employees, and indirectly the company itself.

It's worth noting that there are rare exceptions where common stock could make sense – for example, a hot late-stage company with low risk of failure, or a small business where existing professional investors hold common. For everything else, Wefunder will continue to do what’s right for founders and investors by enforcing the preferred stock requirement.