Founder-friendly stock alternatives II: Getting early liquidity and Class FF preferred

Many successful founders find themselves in the strange position of being stock rich and cash poor, which is troublesome when living in high-cost tech centers like the San Francisco Bay Area, New York, Boston and Los Angeles. Founders can get some relief if they can get some early liquidity by selling shares in a secondary transaction. To support a secondary, the Company should be growing quickly, its financing oversubscribed, and the Company’s board (the “Board”) supportive. Having Class FF preferred may also help.

Class FF Preferred Stock

FF Preferred Stock is essentially common stock with a twist that allows it to be converted to preferred stock. Issued to a founder, it typically can only be converted to the round of preferred stock being sold at the time of a new financing and upon approval of the Board (major investors will also typically be needed to waive applicable restrictions on the sale of founder stock). Using Class FF can help minimize the tax implications to the founder and ensure there is no impact on a Company’s common stock valuation as the founder is essentially selling the latest round of preferred stock once the Class FF is converted.

If a founder decides to use Class FF, it should be adopted at Company formation and represent only a small portion of the founder's stock because, for tax purposes, the stock needs to be granted fully vested. We typically recommend no more than 10 to 25 percent of the overall equity allocated to a founder be Class FF.

Despite its benefits, Class FF is not widely used as it adds additional cost and complication at formation and many founders have found in cases where it would make sense to do a secondary, it has become customary to sell common stock usually at a small discount the last preferred round, with little impact on taxes and valuation of the Company’s common stock. That said, Class FF does facilitate the secondary process and is probably likely worth the efforts (or at least some consideration) at formation.

Class FF allows a founder to avoid any discount on a secondary sale and limits risks related to the Company facilitating a sale above the common stock valuation. Arguably, investors should also like a structure that can help limit dilution the Company shareholders might face from trying to accommodate an oversubscribed round because the founder can sell existing stock, with the added benefit of allowing the founder to raise sufficient monetary resources to be able to patiently work towards a liquidity event that maximizes the value of the Company.