Meaning
Special entitlements or restrictions attach to a specific category of corporate equity to define the privileges of its holders relative to other investors. These class share rights dictate the voting power, dividend priority, and liquidation preferences of each specific group of shareholders. The terms are codified in the articles of incorporation or a shareholder agreement to bind all parties.
They do not apply to debt instruments or general commercial agreements.
Investor Protection
Preferred stock holders receive priority distributions before common shareholders can access company funds. This investor protection ensures that venture capital firms retrieve their initial investment during a liquidity event. The provision prevents founders from extracting value early.
Voting Control
Different categories of equity can carry unequal voting power to preserve the influence of founders over strategic decisions. This voting control allows a startup to raise capital without diluting the decision-making authority of the core management team. It remains effective until a specified sunset event or public offering occurs.
Liquidation Priority
Asset distribution during a wind-up follows a strict hierarchy determined by the share classes. This liquidation priority guarantees that junior shares only receive capital after senior claims are paid in full. It governs the division of proceeds from a sale or dissolution of the business entity.
