I frequently encounter early-stage startups with too many share classes. If you have read previous posts, you know that I advocate for a simple share structure for early-stage companies (usually common and, if needed, non-voting common). If more complex structures are required in the future, they can be created then.
When you are considering your startup’s share structure, consider creating only those share classes that you know you need now or will need. To that end, ask the following questions before creating any share class:
1. What is the share class to be used for? You need to understand the purpose served by each share class. Don’t create share classes because a third party tells you to or because you see other companies with similar structures. Each share class should have a reason for existing.
2. When is the share class to be used? If the share class is to be used at some point in the future, consider whether that class will 100% be suited to that hypothetical future event or will it need to be modified to suit that future event? Further, what is the likelihood of the future event occurring? If it seems unlikely the shares will be used in the future, consider not creating that class. For example, I question the value in creating preferred shares to be used for future investors as you currently do not know what terms those hypothetical investors will want on the preferred share class.
3. Will your share structure agitate investors? Perhaps you do have a future use for 4 share classes but what is the impact of this share structure on your capital raising activities? Will startup investors, used to seeing common share structures (and maybe a non-voting common), take issue with your complex share structure? This especially could be the case where you can’t explain the reason for the structure. Always consider how outsiders will view your share structure.
In sum: don’t create share classes without a reason – even if your lawyer says so! A founder should know their company structure and why it was created that way.