What is a Preference Stack?

A preference stack is the order in which a company's investors are repaid from a sale, and the total they are owed before ordinary shareholders receive anything. Investors take these shares because a company can sell for less than was put into it. Each funding round adds a class with its own amount owed. The classes can rank newest first, or rank equally and share whatever there is. Any debt the company carries is repaid before any of them. Good Technology's charter, filed before its 2015 sale to BlackBerry, set one class at $1.00 a share and another at $4.92.

A preference stack is what a company's liquidation preferences become once there is more than one of them. Each priced round creates a class of preferred shares that is repaid before ordinary shares. The stack is the order those classes rank in and the total they are owed. Investors want that protection because a young company can sell for less than was put into it, and an ordinary share would leave them with a percentage of a poor price. Each round arrives with the same worry and its own class, which is what creates an order to argue about. A company short of cash can be pressed into letting the newest class rank above the ones already there, and the shareholders who must approve it agree when the alternative is a round that never happens. Any debt the company carries is settled before shareholders of any class. Three orders are common. Newest first repays the latest round in full before earlier rounds receive anything. Pari passu, on equal footing, repays every class at once. Tiered groups the rounds, ranks the groups, and pays equally within each. A company raises $2 million at seed, $5 million in Series A and $15 million in Series B, a stack of $22 million, and sells for $15 million. Newest first pays Series B its full $15 million and the other two nothing. Pari passu gives every class the same rate on what it is owed: $15 million against $22 million of claims is about 68 cents in the dollar, so Series B takes $10.2 million, Series A $3.4 million and seed $1.4 million. Ordinary shareholders receive nothing either way. A class can give up its fixed amount and take a percentage of the sale instead, but below the total that always pays less, so the order decides everything. One class repaid before ordinary shares is a liquidation preference. The stack is what appears when several classes must also be ranked against each other.

Two people own a brewery between them. One invested $40,000 years ago and has taken nothing out since. The brewery is weeks from closing and needs $40,000 more, and the only person willing to put it in sets a condition: if the brewery is sold, that $40,000 comes back before the earlier investor sees anything. The earlier investor accepts, because the choice is second place or watching the business close with nothing to divide. The brewery sells a year later for $60,000, less than the $80,000 the two of them put in. Under the condition, the newer money takes its $40,000 and the earlier investor takes the remaining $20,000. Had both ranked equally, each would have taken $30,000. That is a preference stack, two layers deep. The comparison stops at the amounts. Each investor here is owed exactly what was put in, while a real preference can be written at two or three times the money invested.