In a newly-released working paper, we tackle a fundamental financial and governance conundrum that nearly every venture capital (VC) backed company faces: when there are multiple classes of stock, how should directors discharge their fiduciary duties?
In a typical VC-backed firm, the founders and other early employees hold common stock while VC investors hold tranches of preferred stock. As preferred stockholders, VC investors enjoy a variety of special rights, which can include, for example, board representation, consent rights, priority payments upon exit, and options to convert preferred shares or redeem them for cash. But this arrangement bakes a shareholder conflict right into the firm’s capital structure: When strategic business decisions implicate preferreds’ special rights, the interests of preferred shareholders inevitably conflict with those of common. In such cases, what should the board of directors do?
