Do founders get preferred stock

This guide answers “do founders get preferred stock”, explaining founders’ preferred (FF Preferred) vs common, mechanics, tax/accounting issues, market norms, pros/cons, drafting tips, and when Bit...

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Do founders get preferred stock — Practical Guide

Asking “do founders get preferred stock” is common among startup founders planning equity, early secondary sales, or preparing for venture financing. In short: founders most often receive common stock, but a special class called Founders' Preferred (also FF Preferred, Founder Preferred Stock, or Series FF) is sometimes issued at formation to enable limited founder liquidity and to address certain tax and accounting concerns. This article explains what Founders' Preferred is, how it works, why teams use it, typical drafting patterns, market norms, pros and cons, and practical next steps for founders and their advisors.

As of June 2024, according to Orrick and Clerky writeups and other firm resources, Founders' Preferred stock has become an established but still specialized tool among U.S. startups and their counsel.

(Note: this guide is educational. Always consult qualified corporate counsel and tax advisors for your specific facts.)

Quick answer: Do founders get preferred stock?

Short answer: do founders get preferred stock? Usually no — founders typically receive common stock at incorporation. However, some startups issue a limited amount of Founders' Preferred (FF Preferred) at formation or soon after. FF Preferred is a distinct charter class designed to act like common for day-to-day governance but convert into the investor series of preferred when sold into a financing, easing early secondary sales and addressing certain tax/accounting concerns.

This guide covers:

Definition and origin of Founders' Preferred
Core characteristics and conversion mechanics
Tax and accounting considerations (including 83(b) interaction)
Practical drafting elements and market norms
Pros, cons, alternatives, and recommended next steps

Definition

Founders' Preferred Stock (often called FF Preferred, Founder Preferred Stock, Series FF, or Starter Stock) is a specially designed class of equity issued to founders that generally:

Mirrors the day-to-day governance rights of common stock (voting, board participation via ordinary mechanisms),
Lacks separate liquidation preferences beyond common unless expressly granted,
Automatically converts into the investor series of preferred (e.g., Series A Preferred) if the founder sells those shares in a financing or certain targeted secondary transactions,
Is created to allow founders to sell into a priced round at the same price and terms as incoming investors while keeping standard charter mechanics tidy.

Legally, FF Preferred is a form of preferred stock (i.e., a separate class under a company’s certificate of incorporation), but economically it is designed to function like common stock for most purposes while enabling preferred-equivalent treatment in specific secondary sale scenarios.

Core characteristics

When evaluating “do founders get preferred stock” in practice, these are the core features you’ll encounter:

Day-to-day parity with common. FF Preferred usually carries the same voting rights and governance profile as the founders’ common. Founders retain founder control patterns unless the charter specially alters voting.
Automatic conversion for secondary sales. A key characteristic is an automatic conversion mechanism: if a founder’s FF Preferred shares are sold to new investors or in a financing, those shares convert into the series of investor preferred being sold so the buyer receives preferred, not a different class.
No separate liquidation preference (usually). To keep economics simple and avoid upsetting liquidation math, FF Preferred commonly does not carry a standalone liquidation preference beyond what common holders receive. The idea is not to create a senior economic class for founders.
Full vesting for tax reasons. For tax and accounting clarity, founders’ FF Preferred is commonly issued fully vested at grant (i.e., not subject to repurchase upon termination) so that later secondary sales are less likely to be treated as compensatory ordinary income.
Size limits. Companies typically limit the amount of founder stock issued as FF Preferred (for example, a minority slice of the overall founder pool — see Practical norms below).

History and origin

Founders' Preferred emerged as a practical response to issues that arose when founders sought to sell shares before a priced round. Historically:

Startup counsel and early venture partners noticed that selling founder common into a financing created awkward outcomes: investors wanted to buy preferred, secondary buyers wanted the protections attached to preferred, and selling common at a high price could trigger tax concerns for founders if the IRS viewed the sale as compensatory.
Law firms and templates (notably Orrick and other prominent Silicon Valley counsel) developed FF Preferred constructs and accompanying certificate language to allow founders to hold a form of stock that could be treated like investor preferred only upon transfer into a financing.
Over time, Clerky, LTSE materials, and startup advisory firms documented common drafting patterns. The structure has been adopted in a minority but meaningful subset of U.S. startups, particularly where early secondary liquidity for founders is anticipated.

How Founders' Preferred works

This section explains the typical lifecycle and mechanics so you can decide whether FF Preferred fits your startup’s plans.

Typical issuance timing

Founders' Preferred is most often issued at incorporation or very shortly afterward, alongside founder common. Early issuance is preferred because:

It avoids later complications in valuation and tax consequences that could arise if a new preferred class is created after founders have already accepted common.
It gives clarity for future financings and secondary transactions.

Conversion trigger and purpose

A central piece of FF Preferred is the conversion trigger. Typical language states that FF Preferred will automatically convert into the series of preferred being issued to investors (for example, Series A Preferred) only if the FF Preferred shares are transferred in connection with the financing or otherwise sold to third parties in transactions where new investor preferred is being issued.

Purpose:

Investors who buy secondaries will receive the same preferred rights they negotiated for the round.
Founders who sell in secondary transactions are able to sell stock that will become investor-preferred upon transfer, matching price and protections.

Example flow

Founders receive a mix of FF Preferred and vesting common at incorporation (e.g., 20% of founder pool as FF Preferred for potential secondaries, 80% as common subject to vesting and repurchase).
An investor-led Series A round closes; the company issues Series A Preferred to investors.
A founder sells some FF Preferred into investor participation or to a third-party purchaser during that Series A transaction. Under the conversion clause, those FF Preferred shares automatically convert into Series A Preferred and the buyer receives the negotiated Series A rights.

This automatic conversion streamlines economics and governance: purchaser receives the same protections as other Series A holders, and founder sellers receive market price without turning their common into a differently treated instrument.

Conversion mechanics and purpose

Why include conversion mechanics? They serve both investor and founder interests:

Investor perspective: VCs and other investors want to avoid buying a class of shares that lacks the negotiated liquidation priorities, anti-dilution protections, and other preferred-side governance provisions they expected to receive. An automatic conversion ensures any purchased founder shares carry the same protections.
Founder perspective: Founders who sell early want to receive capital gains on a sale of capital stock, not ordinary income. Issuing FF Preferred with automatic conversion can help structure a secondary sale so the founder sells a share that becomes preferred upon sale — aligning buyer expectations and price with investor-preferred economics.

However, conversion mechanics do not create guaranteed tax outcomes. They merely aim to align the economic substance and contractual form to reduce the risk of later tax characterization issues.

Vesting and transfer rules

A common design uses a mix of fully vested FF Preferred plus vesting common stock:

FF Preferred: Often fully vested when issued to avoid creating compensatory sale issues if sold. Full vesting means the company cannot repurchase the shares based on termination, which is what can create ordinary income characterization in some IRS views.
Vesting common: Founders typically also receive common stock that remains subject to vesting and company repurchase rights. This preserves the company’s ability to reclaim unvested economic value if a founder leaves prematurely.
Transfer restrictions: FF Preferred usually carries the same transfer restrictions as other shares — right of first refusal (ROFR) for the company, co-sale / tag-along rights for other shareholders, and other standard restrictions. These ensure orderly secondary transfers.

The mixed approach balances the founders’ need for protection and company control with the tax rationale for fully vested shares available for sale.

Tax and accounting considerations

A major driver for issuing FF Preferred is tax and financial reporting comfort around early secondary sales. Key considerations include:

Risk of compensatory treatment: When a founder sells common shares at a price significantly above the founder’s tax basis or above the company’s last 409A valuation, the IRS or other regulators could argue part of the sale reflects compensation rather than capital gain. That could recharacterize proceeds as ordinary income.
FF Preferred rationale: By issuing a fully vested class of FF Preferred that converts into investor preferred on sale, founders try to ensure that when they transfer those FF Preferred shares, the transaction looks like an arm’s-length sale of capital stock at market price rather than a compensatory payment by the company.
No guarantee: The IRS has not issued specific safe-harbor rulings that universally bless FF Preferred structures. Tax outcomes depend on facts and circumstances, and counsel must analyze valuation history, structure timing, and whether the sale truly reflects capital transaction versus disguised compensation.
Accounting: For accounting (ASC 718) and cap table reporting, FF Preferred is a separate equity class, so companies should account for it properly in equity statements and cap table models. If founders are retained via vesting common plus fully vested FF Preferred, the company should document rationale and board approvals.

83(b) election and valuation issues

83(b) interaction: Founders typically file 83(b) elections on restricted common to accelerate recognition of taxable income at the time of grant (when the fair-market value is low) and to preserve capital gains treatment on later appreciation. FF Preferred issued fully vested usually does not require an 83(b) because there is no substantial risk of forfeiture to accelerate.
Valuation timing: Creating FF Preferred after incorporation or after a material increase in value can complicate tax outcomes. Early issuance (at or near incorporation) at a low value is simpler from a valuation standpoint.
Documentation matters: Board minutes, advisors’ memos, and clear charter language help support the structure’s economic rationale for tax and accounting reviewers.

Always involve experienced tax counsel before relying on any tax benefits of FF Preferred.

Why founders might receive preferred stock

Founders and companies consider FF Preferred for several reasons:

Early secondary liquidity: Founders expecting to sell a small percentage of their holdings early can use FF Preferred to make secondary transactions clean for investors.
Investor symmetry: Buying founders’ stock in a priced round can be awkward if investors expect preferred. FF Preferred ensures buyers receive preferred economics.
Tax posture: Issuing fully vested FF Preferred can reduce the risk that a subsequent sale is characterized as compensation.
Simpler charter mechanics for future financings: FF Preferred allows the company to document founder liquidity plans without issuing a permanent separate privileged class.
Attracting talent and managing option pool: A small allocation of FF Preferred to founders can leave the bulk of founder shares under traditional vesting common so the company keeps repurchase rights and option pool economics intact.

Practical terms and market norms

When evaluating “do founders get preferred stock” in real deals, expect these market norms:

Frequency: FF Preferred is still a minority practice. Most startups simply grant common to founders and handle secondaries ad hoc.
Typical size: When used, FF Preferred usually covers a modest portion of overall founder holdings — often in the single-digit to low double-digit percentage of the company’s total capitalization or the founder pool (e.g., representing the shares a founder might sell in an early secondary). Typical practical buckets cited by counsel range from 5% to 25% of founder shares, but norms vary widely.
Issuance timing: Issued at incorporation or shortly thereafter; late creation can raise questions.
Investor reaction: Most VCs will accept modest FF Preferred used solely to enable early founder liquidity. Investors become concerned if the instrument confers extra governance rights (super-voting) or economic preferences that reduce investor protections.
Charter drafting: Key items in the certificate of incorporation usually include the conversion trigger language, absence (or limitation) of liquidation preference for FF Preferred, transfer restrictions, and limits on the total FF Preferred pool.

Pros and cons

Weighing whether founders should receive preferred stock requires balancing benefits and tradeoffs.

Pros

Facilitates early founder liquidity consistent with investor protection needs.
Helps align the form of transferred shares with investor-preferred economics.
Reduces (but does not eliminate) tax risk that a sale is recharacterized as compensation.
Keeps founder governance mechanics straightforward for daily operations.

Cons

Adds charter complexity and legal drafting costs.
Fully vested FF Preferred removes the company’s repurchase leverage on that portion of founder stock.
If not carefully drafted, FF Preferred can create unintended economic or governance consequences, including impacting liquidation preference math.
Some investors may resist or require concessions if the class creates perceived advantages for founders.

Investor / VC perspectives

VCs generally evaluate FF Preferred with practical skepticism but will often accept modest, well-documented uses. Investor considerations include:

Rights parity: VCs expect any share they buy to carry the negotiated rights. FF Preferred that converts on transfer satisfies that.
Governance and economics: VCs dislike super-voting founder-only rights or extra liquidation preferences. Founders should avoid structures that create disproportionate economic upside without investor consent.
Size and disclosure: VCs prefer FF Preferred to be limited in size and fully disclosed in the purchase agreement and cap table.
Negotiation points: Investors may ask for contractual protections (e.g., that FF Preferred cannot be converted into a separate superior class, or that the conversion triggers are narrow) to avoid surprises.

In practice, transparent drafting and modest sizing minimize investor resistance.

Alternatives to founders preferred stock

If FF Preferred doesn’t suit your situation, common alternatives include:

Selling founder common in a secondary with investor sign-off: Simpler but carries tax and buyer-protection risks.
Special-purpose secondary vehicle or structured purchase: Using an SPV or investor co-investment to buy founder shares without altering the charter, though complex.
Deferred liquidity: Postponing founder sales until an exit or public offering avoids early complexity.
Governance-only classes (super-voting common): Some founders seek governance control via super-voting stock instead of FF Preferred, but investors often resist governance entrenchment.

Each alternative carries tradeoffs on tax, governance, and investor appetite.

Legal, incorporation and drafting considerations

If your team concludes FF Preferred may help, consider these drafting and process points:

Implement at incorporation. Creating FF Preferred at the start is cleaner and reduces valuation and tax complications.
Use clear charter language. The certificate of incorporation should plainly state conversion triggers, limitations on liquidation preferences for FF Preferred, transfer restrictions, and a cap on the FF Preferred issuance.
Document rationales and approvals. Board minutes, founder consent, and legal opinions should capture why FF Preferred was used and how it will be treated.
Tax and accounting review. Obtain tax counsel to evaluate expected outcomes, and involve finance/accounting to ensure correct reporting.
Consider mixing FF Preferred with vesting common. Most companies combine fully vested FF Preferred for the shares the founder may sell and vesting common for retention and repurchase leverage.

Typical drafting elements

Common clauses include:

Automatic conversion trigger when FF Preferred is transferred in connection with a financing or to a purchaser who is receiving investor preferred in the same transaction.
A cap on FF Preferred shares or percentage (e.g., no more than X% of issued and outstanding shares at formation or a cap on founder-side FF Preferred issuance).
Statement that FF Preferred carries no separate liquidation preference beyond common unless expressly provided.
Transfer restrictions such as ROFR, co-sale rights, and standard securities law legends.
Statement that FF Preferred is fully vested on issuance, while additional founder common may be subject to vesting and repurchase under founder agreements.

Drafting should be concise, explicit, and reviewed by experienced counsel.

Typical use cases and prevalence

Founders tend to consider FF Preferred in these situations:

They expect early secondary sales (e.g., to employees, early investors, or family offices) concurrent with a priced financing.
They want to reduce the friction of investors buying founder-held shares in the round.
The company or its counsel anticipates tax or accounting scrutiny around early transfers and wishes to use charter mechanics to mitigate risk.

Despite these use cases, FF Preferred is not the norm across all startups — it remains a targeted tool adopted by teams with specific liquidity plans or counsel recommendations.

Examples and templates

Several law-firm writeups and incorporation platforms provide sample wording and practical checklists describing FF Preferred. Common sources used by practitioners include Orrick’s explanatory pieces, Clerky templates, LTSE guidance, and detailed writeups by boutique startup counsel. Reviewing these samples with corporate counsel helps craft company-specific charter language.

FAQ

Q: Do founders normally get preferred?

A: Generally no. Founders usually receive common stock. Founders' Preferred is a special, less-common class used selectively.

Q: Can founders get VC-style preferred rights?

A: It’s uncommon. Giving founders full investor-style preferred rights (e.g., liquidation preference, anti-dilution) is atypical and likely to create investor pushback.

Q: Is FF Preferred taxable as ordinary income when sold?

A: Tax treatment depends on facts. FF Preferred is designed to reduce the risk of compensatory characterization, but outcomes are not guaranteed. Consult tax counsel.

Q: Can FF Preferred be vested?

A: Typically FF Preferred intended for sale is fully vested. Companies often pair FF Preferred with separate vesting common to preserve repurchase rights for retention.

When to consider FF Preferred

Consider FF Preferred if:

You expect to sell founder shares in or around a priced financing,
You want buyers to receive preferred protections without secondary complexity,
Your counsel recommends it based on tax/accounting analysis.

Avoid it if the added charter complexity, legal cost, or investor discomfort outweighs the expected liquidity benefit.

Practical checklist before issuing FF Preferred

Confirm the business need and likely transaction scenarios for secondary sales.
Consult corporate counsel and tax advisors; get written recommendations.
Prefer issuance at or near incorporation time.
Cap the FF Preferred pool and specify conversion triggers narrowly.
Ensure vesting/common mix preserves company repurchase leverage and retention incentives.
Document board approvals and rationale thoroughly.
Communicate openly with prospective investors about the structure and size.

Final thoughts and next steps

When founders ask “do founders get preferred stock?”, the right answer depends on the company’s liquidity plans, investor expectations, tax posture, and tolerance for charter complexity. Founders’ Preferred is a useful but specialized tool: it can enable early liquidity and simplify buyer expectations while introducing drafting and investor-relations tradeoffs.

If you are considering FF Preferred:

Discuss your objectives with experienced corporate counsel and tax advisors.
Aim to design narrow conversion triggers, limit size, and pair FF Preferred with vesting common to preserve retention mechanisms.
Prepare transparent disclosures for investors and document the board’s rationale.

Want to explore tools that help founders and teams manage equity and early liquidity? Check out Bitget resources for startups and learn how Bitget Wallet supports token and asset management (for Web3 contexts). For corporate-equity questions, consult a qualified law firm recommended by your advisors.

References

Orrick: What is Founders Preferred Stock? (practitioner writeups and sample clauses).
Clerky Handbook: FF Preferred Stock and typical charter language.
LTSE: What type of equity should be issued to founders?
Kruze Consulting: Founder Preferred Stock explained (tax/accounting context).
Morse Law: Practical observations on FF Preferred.
Westaway & StartupPercolator: VC and market perspectives.

(As of June 2024 these practitioner sources provide template language and analysis frequently used by counsel.)

Next step: If you want a sample drafting checklist or sample charter clause for FF Preferred tailored to a Delaware C-corp, ask and we’ll expand this guide with actionable language and a short drafting checklist.

The content above has been sourced from the internet and generated using AI. For high-quality content, please visit Bitget Academy.