Venture Financing Tips: Preferred Stock and Valuation

Hear from Jesse Jones, Fourscore Business Law Founder, about How To Structure an Equity Deal. In this video, he will discuss your relationship with your investor, the difference between preferred stock and common stock, company valuation, and your exit strategy. Stay tuned for the next video in our Venture Financing Tips series and subscribe to our monthly newsletter full of resources here.

For entrepreneurs, the prospect of raising funds to propel business growth should come with a mix of excitement and fear. While taking angel and venture capital isn’t right for every startup, it may be the ideal financial structure to help you scale.

Download our whitepaper here, including a directory of funding sources in North Carolina and the Southeast.

Venture capital gives you the opportunity to raise significant amounts of funding by essentially selling a part of your company as you build it. For that reason, entrepreneurs should understand that angel and venture capital is typically expensive money, so the smartest entrepreneurs will make sure to seek outside capital from those that can provide value in terms other than simply dollars.

If you are planning to meet with a potential investor, understanding what to expect when it comes to structuring venture deals will help ensure you get started on the right foot. 

Venture Financing Tips: Preferred Stock and Valuation

Preferred stock and valuation. When you take on investors, you're not just raising money, you're entering a long-term partnership. In many ways, it's like a marriage.

Once they're in, they're in until the company exits. And that's why understanding how these deals are structured is so important. In most venture and angel financings, investors don't buy common stock, they buy preferred stock.

Now, both represent ownership, but preferred stock comes with special rights. Things like liquidation preferences, voting rights, and additional protections that common stockholders, like founders, don't have. That's normal, and it's standard, but you need to understand what it means. So let's talk about one of the biggest negotiation points in any deal, valuation.

Valuation determines how much of your company you're giving up in exchange for the investment. Naturally, founders want the valuation as high as possible, and investors want it as low as possible.

But here's where founders often make a critical mistake. They push for a valuation that's too high, too early, and that can backfire because your next round has to build on this one. If your business doesn't grow into that valuation, you could be forced into a down round, which hurts your credibility and creates complications with investors.

So instead of asking, what's the highest number I can get, ask, what is a number that I can grow into? You want steady, believable progress over time. Because the real goal isn't just closing this round, it's setting your company up for the next one, and ultimately, a successful exit. For more venture financing tips and resources, visit fourscorelaw.com and check out our YouTube channel.

Common Questions About Preferred Stock and Valuation

• Q: What is preferred stock and why do investors get it instead of common stock?

  A: Preferred stock gives investors special rights that common stockholders don't have, including liquidation preferences and voting protections. It's standard in venture and angel financing deals, but founders need to understand what those extra rights mean for them.

• Q: How does startup valuation work when raising money from investors?

  A: Valuation determines how much of your company you give up in exchange for investment. Founders want it high, investors want it low — and getting this number right is one of the biggest negotiation points in any funding deal.

• Q: What happens if I set my startup valuation too high in NC?

  A: Setting your valuation too high too early can backfire if your business doesn't grow into it, potentially forcing you into a "down round." This damages your credibility and creates complications with existing and future investors.

• Q: What valuation should I aim for in my first funding round?

  A: Aim for a valuation you can realistically grow into, not just the highest number you can get. The goal isn't only closing the current round — it's setting your company up for the next round and a successful exit.