Meaning
Distribution of ownership interest through different classes of stock or specific contractual rights creates a hierarchy among the holders. This structural equity allows for the separation of economic value from voting power or liquidation preference. It is the mechanism used to give founders more control while giving investors more protection in a downside scenario.
Structure is documented. The details are recorded in the capitalization table and the corporate charter.
Preference Layer
Paying out investors before the founders in a sale is a common feature of this arrangement. Known as a liquidation preference, this part of structural equity ensures that a certain amount of capital is returned to the providers before any profit is shared. It reduces the risk for the investor and can significantly impact the founder’s final payout.
Voting Control
Issuing multiple classes of shares allows a founder to keep a majority of the votes even with a minority of the total stock. This structural equity design is often used to protect the long term vision of the company from the short term pressures of the market. It requires a specific provision in the bylaws that gives one class of shares more votes per share than another.
Ratchet Mechanism
Adjusting the ownership percentage if the company fails to hit certain milestones is a way to protect the value of an investment. Some structural equity includes anti-dilution clauses that grant more shares to an investor if a subsequent round is raised at a lower price. This protects the buyer from the cost of a down round but can increase the dilution for the founders.
