Common Stock

What Is Common Stock?

Common stock is the most basic form of equity ownership in a corporation. When startup employees exercise their stock options, the shares they receive are almost always common stock. Unlike preferred stock — which is typically held by venture capital investors and comes with special rights — common stock represents a residual claim on the company's assets and earnings. This means common stockholders are last in line to receive proceeds in a liquidation or acquisition, after debt holders and preferred stockholders have been paid.

Despite this subordinate position, common stock is the foundation of employee equity compensation. The potential upside of common stock can be substantial: if the company succeeds, common stockholders share in the growth. And because common stock is valued lower than preferred stock at the time of grant (due to the lack of investor protections), employees benefit from a lower exercise price on their options.

How Common Stock Works

Common vs. Preferred Stock

The most important distinction for startup employees is between common stock and preferred stock. Investors in venture-backed companies receive preferred stock, which comes with a set of negotiated rights:

• Liquidation preference: Preferred stockholders get paid first (often 1x their investment or more) before any proceeds flow to common stockholders.
• Anti-dilution protection: If the company raises money at a lower valuation, preferred stockholders may receive additional shares to protect their ownership percentage.
• Conversion rights: Preferred stock can typically be converted to common stock on a 1:1 basis, which investors do when it is more profitable (usually at IPO).
• Participation rights: Some preferred stock is "participating," meaning investors get their liquidation preference and then share in the remaining proceeds alongside common stockholders.

Common stock has none of these protections. However, it does carry voting rights (typically one vote per share) and the right to receive dividends if declared — though private companies rarely pay dividends.

The Discount for Lack of Protections

Because common stock lacks the protections of preferred stock, it is valued lower in 409A valuations. A company that just raised at $10 per preferred share might have its common stock valued at $3–$5 per share. This discount benefits employees because it means a lower strike price on their options and a smaller initial cash outlay to exercise.

Common Stock and the Cap Table

The cap table tracks all equity ownership in a company. Common stock typically includes shares held by founders, shares issued to employees upon exercise of stock options, and shares reserved in the option pool for future grants. Understanding your position on the cap table — including how many total common shares are outstanding and what percentage your shares represent — is essential for estimating the potential value of your equity.

Practical Implications for Startup Employees

Your Shares Are Worth Less Than the Headline Valuation

When you hear that your company raised at a "$1 billion valuation," that valuation reflects the price paid for preferred stock. Your common shares, by contrast, sit below preferred stock in the capital structure. In a modest exit — say $200 million — the preferred stockholders might recover their full investment first through liquidation preferences, leaving a smaller pool for common stockholders. In a large exit, the difference diminishes because preferred holders typically convert to common when it is more advantageous.

Dilution Over Time

Each time the company raises a new funding round, it issues new preferred shares. This dilutes the ownership percentage of existing common stockholders. While the per-share value may still increase if the company's total valuation rises, your percentage of the company decreases. Understanding your fully diluted ownership — which accounts for all outstanding shares and options — gives you a more realistic picture of your equity's potential value.

Common Stock Restrictions

Common stock in private companies is almost always subject to restrictions. You may face transfer restrictions that prevent you from selling your shares on secondary markets. A right of first refusal (ROFR) may give the company the right to buy your shares before you can sell them to anyone else. And if you received shares through early exercise, the company may have a repurchase right on unvested shares.

How It Relates to Exercising Stock Options

When you exercise stock options, you are purchasing common stock at your strike price. The shares you receive sit at the bottom of the capital stack, below all classes of preferred stock. This subordinate position affects the realistic value of your equity — particularly in exit scenarios that fall below the company's total raised capital. Before exercising, consider the company's total liquidation preferences relative to its current valuation, and model scenarios where the exit price varies. This will help you understand the range of outcomes for your common shares.