Preference shares in your startup’s funding deal? Be careful

When a startup raises a new round of funding, congratulations often flood in for the founders. However, the behind-the-scenes details are rarely discussed, and these can turn out to hamstring a fledgling company.

The terms of a fundraise are typically explained in the shareholders’ agreement (SHA) and subscription agreement. These agreements hold critical implications for existing shareholders and the startup’s management, as they define key economic and control rights for the company.

Image credit: Timmy Loen

As startups transition from early-stage (seed to series A) to late-stage (series B and beyond) funding rounds, these agreements grow increasingly complex, which can feel overwhelming for many founders.

But what are the common industry-standard clauses for these agreements? And what are the less conventional terms that startup founders should be wary of when closing funding deals?

Preference shares are top of the list. Here’s why.

A matter of preference

Preference shares, or preferred stock, typically play a key role in an SHA. With every equity round, new classes of preference shares can be introduced, representing the specific interests of each new group of investors.

These shares are a class of equity that provides investors certain privileges ahead of common shareholders, particularly in economic and control rights. They are often issued to investors as part of funding rounds and come with specific terms designed to protect the investment.

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Economic rights are the financial entitlements investors receive in return for their capital, dictating how they will benefit from the company’s financial success. These include profits, dividends, and distributions from an exit event, such as a sale, merger, or IPO.

Control rights are mechanisms that allow investors to influence or manage the company’s strategic decisions. These rights ensure that investors can protect their interests and have a say in major corporate decisions.

Common industry standards

In Singapore, certain industry standards have emerged regarding the formation of preference shares. In 2018, the Singapore Academy of Law and the Singapore Venture Capital Association collaborated to establish standardized venture capital agreements.

In a standard SHA, there are 10 key clauses and seven essential rights granted to preference shareholders. A notable feature is the creation of a new class of preference shares, which generally rank senior to other classes, offering a 1x liquidity preference and one vote per share.

Unconventional clauses and their impact

Balance of power