Why Preferred and Common Stock Have Different Values
When a startup's Series A investor pays $2.00 per preferred share and the 409A values common stock at $0.60 per share, many founders are surprised and confused. Both represent equity in the same company — why are they worth such different amounts?
The answer lies in the fundamentally different economic rights attached to each security. Preferred stock is not just "equity" — it is a structured financial instrument with contractual protections that make it significantly more valuable in a range of exit scenarios.
Rights That Make Preferred Stock More Valuable
| Right | Preferred Stock | Common Stock |
|---|---|---|
| Liquidation preference | Gets paid before common in any exit | Paid only after all preferred preferences satisfied |
| Participation | May share in proceeds above liquidation preference | Only participates after all preferences paid |
| Anti-dilution | Adjusts conversion ratio in down rounds to protect ownership | No adjustment — diluted pro rata |
| Dividends | Priority dividend rights (cumulative in some cases) | No dividend rights typically |
| Conversion | Can convert to common at will; auto-converts at IPO | No conversion rights needed |
| Board rights | Often includes board seats or observer rights | No governance rights beyond voting |
| Information rights | Contractual access to financials and board materials | No statutory information rights |
How the OPM Quantifies the Discount
The Option Pricing Model calculates the preferred/common discount by mapping the payout waterfall and probability-weighting all possible exit outcomes. Common stock only participates meaningfully in exit proceeds above the aggregate liquidation preference stack. In scenarios below the stack, common gets zero.
Because there is a meaningful probability of exits in the range where common receives little or nothing, the expected value of common stock is mathematically lower than the expected value of preferred stock — even if the company's total enterprise value is the same.
The Discount by Stage
| Stage | Typical Common/Preferred Ratio | Preferred/Common Discount | Primary Driver |
|---|---|---|---|
| Pre-Seed / Angel | 10–20% | 80–90% | High binary risk, minimal revenue, very small preference stack relative to enterprise value uncertainty |
| Seed | 25–35% | 65–75% | Small preference stack but high DLOM and enterprise value uncertainty |
| Series A | 35–45% | 55–65% | $5–15M preference stack, OPM shows common is zero below threshold |
| Series B | 45–60% | 40–55% | Growing stack but also growing enterprise value and narrowing DLOM |
| Series C | 60–75% | 25–40% | Large stack but IPO candidacy narrows the gap |
| Pre-IPO | 80–95% | 5–20% | Preferred converts to common at IPO — discount essentially disappears |
Why This Is Good News for Employees
The preferred/common discount is not a problem — it is a feature that directly benefits employees receiving stock options. Because common stock is priced lower than preferred:
- Employees' option strike prices are lower, meaning more potential upside per share
- The absolute dollar amount needed to exercise options is lower
- In a high-value exit where preferred converts to common (above the liquidation stack), common and preferred shareholders share equally — employees benefit fully from the upside
The discount protects employees from being taxed on "phantom" preferred-level value that they don't actually hold economically — which is exactly what §409A was designed to prevent.