Preferred Shares

Preferred shares are shares with special rights compared with common shares. These include, for example, a liquidation preference or a preferred dividend. Investors receive them to better protect their capital. The bundle of rights extends beyond the distribution of proceeds and may include anti-dilution protection, consent rights over material decisions, information rights, a board seat and pro-rata rights for later rounds. Conversion into common shares is also frequently addressed, for example in connection with an initial public offering.

The actual rights depend on the governing corporate and investment documents. A German GmbH can also issue interests carrying different economic and other rights. These are structured through the articles and supplementary shareholders' agreement. The implementation differs from share classes commonly used in Anglo-American jurisdictions, but the economic objectives can be comparable. A distinction should be drawn in particular from non-voting preference shares under German stock corporation law: these combine a preferred dividend with the exclusion of voting rights, whereas venture capital investors generally also seek influence over decisions.

Economically, the key question is how the preferential rights operate at different exit values. A liquidation preference may give investors an agreed amount before common shareholders participate in the proceeds. At higher exit values, conversion into common shares may become more attractive. Whether preferred holders also participate in the remaining proceeds depends on the specific terms. The price paid for a preferred share therefore cannot simply be applied to a common share.

Later financing rounds may create additional classes with their own rights. These may rank ahead of, alongside or behind existing classes. Founders and investors therefore need to compare more than ownership percentages and the headline company valuation. They should also assess how much each holder actually receives at different exit values after all preferential rights have been applied.

Note: This explanation is for general information only and does not constitute legal advice. The legal position depends on the individual case and may change with new legislation or case law. For a binding assessment, please consult a qualified lawyer.