Founders Preferred Stock (commonly known as “Series FF Preferred Stock” or “FF Stock”) is a special type of stock issued to founders, usually at the time of incorporation, that by its terms will automatically convert into a future series of preferred stock if the founder sells it to a company’s new or existing investors at the time of such a future financing.
FF Stock is intended to benefit:
- Founders who can sell the stock for the preferred stock price at the time of a financing.
- Investors who can buy from the founder the same series of preferred stock as the company is selling during a financing, instead of the common stock, they would usually get when buying shares from a founder.
- The company, because the sale of such preferred stock at a high price will have less of an impact than the sale of its common stock at a high price on the 409A common stock valuation of the company. The common stock valuation of a company is preferably kept lower in order to maintain the ability of the company to incentivize employees with lower-priced equity awards.
FF Stock typically has the following terms:
- Must be fully vested due to tax rules. FF Stock normally constitutes no more than 25% of a founder’s total equity in the company, with the remainder of the founder’s equity being common stock subject to vesting.
- The sale is subject to the approval of the company’s board of directors.
- If FF Stock is transferred to anyone other than an approved investor, it converts into common stock and all of the preferred terms of the stock are terminated.
- Other than the conversion feature, FF Stock has the same rights as the common stock and is junior to any other preferred stock.
Planning ahead is important when considering FF Stock. If FF Stock is not issued at incorporation, it becomes more difficult to appropriately value FF Stock at a later point in time, which may result in a founder paying more than a nominal amount to purchase shares of FF Stock. This reduces the potential upside of holding FF Stock.
FF Stock has been around for over a decade, but it has not been widely adopted. Many investors and startup lawyers are familiar with FF Stock and it generally does not cause any issues with investors. It seems that the upfront legal costs of implementing FF Stock and additional costs of maintaining a more complicated capitalization structure have dampened the appeal of FF Stock. Additionally, it is not clear that FF Stock improves the ability of a founder to achieve early liquidity. In early financing rounds, investors may insist on buying stock directly from the company for tax reasons (e.g., stock purchased directly from the company may qualify for status as qualified small business stock) or for legal reasons, such as receiving representations and warranties directly from the company. In later financing rounds, FF Stock also loses its advantage of “bridging the gap” between the common stock price and the preferred stock price because the respective prices tend to converge.