What is the difference between common shares, preferred shares, SPV units and stock options?

When you invest in or receive equity compensation from a private company, you can potentially reap substantial returns in the future. However, this opportunity comes with complexity and risk. The private market offers different types of securities, with the most common including common shares, preferred shares, special purpose vehicle (SPV) units and stock options—each which come with different rights, privileges and consequences regarding returns, voting and control.

In this article, we will explore the definitions and attributes of common shares, preferred shares, SPV units and stock options within the framework of the private market and highlight their distinctions. For those who are assessing their stock holdings as employees or exploring potential pre-IPO investment opportunities, this article provides an overview of the typical ownership structures in private companies to help guide informed decision making.

What are common shares?

Common shares, often referred to as common stock, represent a foundational ownership stake in a private company. They typically come with voting rights, giving shareholders a say in major company decisions—such as electing board members or approving mergers. Other common share considerations include:

• While the standard is one vote per share, there may be variations in voting structures where some types of common shares have more votes per share.
• Common shareholders may receive dividends, but there is no fixed guarantee.
• Common shareholders receive payment only after all other claims have been resolved during a liquidity event.

Startups and private companies often distribute common stock to their founders and early employees as part of equity compensation programs. In situations such as an acquisition or bankruptcy, common shareholders usually have the lowest priority when it comes to liquidation, behind creditors and preferred shareholders.

What are preferred shares?

Preferred shares (also known as preferred stock) are a form of ownership that usually includes specific privileges and advantages that are not accessible to common shareholders. Preferred shares are often issued to venture capitalists (VCs) and institutional investors by private companies. Preferred share considerations include:

• Holders are typically paid out before over common shareholders in the event of an exit event (commonly known as the “liquidation preference”).
• Dividend rights often consist of fixed or cumulative dividends.
• Convertible rights typically include an opportunity to have the shares converted into common shares, usually under specific conditions, such as an IPO.
• Heightened voting rights, such as the ability to elect one or more members of a company’s board of directors and the power to veto certain significant corporate actions, such as incurring significant debt, entering into material commercial contracts, or changing the company’s line of business.
• Anti-dilution protection and rights of first refusal (ROFR).

What are SPV units?

A special purpose vehicle (SPV) is a legal entity created for a specific purpose and is typically used to isolate and manage financial risks. SPVs are commonly used in complex financial transactions such as securitization, asset-backed securities and project finance. The SPV can be a subsidiary of a larger parent company or an independent entity, with its assets, liabilities and operations typically separate from those of the parent company. The use of an SPV allows investors to invest in specific assets while limiting their exposure to the overall financial health of the parent company.

SPVs can be used by investors to invest in an array of private companies. When a group of investors wants to invest in a private company, they can create, or invest in, an SPV that will hold the investment on behalf of the investors. The investors will then own a portion of the SPV, or an ‘SPV unit,’ which will, in turn, own a portion of the private company.

The operations of the SPV are typically managed by a general partner (GP), while investment decisions of the SPV are generally handled by an investment manager (sometimes an affiliate of the GP). The investment manager is often a venture capital firm or another professional investment manager, although in some cases, it may be an individual investor who has experience in the industry or sector in which the portfolio companies of the SPV operate.

For the private company, an SPV investment can provide it with access to capital from a group of sophisticated investors, who may have industry expertise and connections that can help the company grow and succeed. The SPV investment also provides the company with a simpler ownership structure, as the SPV can be treated as a single shareholder on the company's cap table, rather than having multiple individual investors.

For investors, the following are some distinct advantages of investing in SPVs:

Foremost, SPVs are tailored for specific investment opportunities, allowing investors to participate in a singular, well-defined opportunity. For example, an SPV may be created to invest in a pre-IPO company, such as OpenAI, Anthropic, Databricks, SpaceX, or another private company. This targeted approach enables investors to:

One of the primary benefits of an SPV is its ability to compartmentalize risk. By design, an SPV’s liabilities are isolated from its sponsor or parent entity. For investors, this means:

This feature provides a safety net, especially in volatile or high-stakes sectors. However, as with other investment opportunities, SPVs can have limitations or challenges, including the cost to establish and maintain, the complexity of some SPVs and the duty to comply with applicable regulations.

SPVs often provide access to opportunities that might otherwise be unavailable to individual investors. Institutional investors or experienced sponsors create SPVs to pool resources for high-value deals. Benefits include:

SPVs can be highly customizable, offering flexibility to meet the needs of both sponsors and investors. They can be structured as limited liability companies (LLCs), limited partnerships (LPs), or trusts, depending on the jurisdiction and investment type. This adaptability allows investors to:

Pooling capital through an SPV simplifies the investment process for both sponsors and investors. For investors, this means:

This streamlined approach reduces the time and effort required to engage in private market investments.

By participating in SPVs, investors can add niche opportunities to their portfolios without committing significant resources to build direct positions. This is particularly beneficial in the private market, where diversification can mitigate risks and enhance returns. SPVs create an opportunity for investors to:

Private market investments can present opportunities for outsized returns compared to the public market. SPVs provide a vehicle to access these opportunities, particularly in sectors experiencing rapid growth. With the right sponsor and a sound investment thesis, investors have the potential to benefit from significant capital appreciation over time.

Investing in SPVs can also have several disadvantages for investors. These include a potential lack of diversification, potential for preferential treatment, no voting rights and the fees associated with SPVs. In addition, sometimes SPVs can be complex, feature limited transparency and may lead to illiquidity.

What are stock options?

Stock options are contracts that give the holder the right, but not the obligation, to buy shares (typically of common stock) at a predetermined price (commonly known as the strike or exercise price). Often referred to as simply options, private companies often include them as part of their employees' compensation packages. Other options considerations include:

• Options typically vest over a specific timeframe, commonly through a four-year vesting schedule with a one-year cliff. For example, if someone is granted 100 shares, 25 shares would vest and be exercisable after the first year and the rest would vest monthly/quarterly thereafter for the next three years.
• The fair market value of the company’s common stock typically determines the strike price at the time of the option grant.
• Those with options do not possess shares or the rights of a shareholder until they exercise their options and acquire the underlying shares of common stock.
• When a company is private, it is not guaranteed that you can sell shares after exercising your options, unless there’s a company tender offer. In contrast, when a company goes public, this restriction goes away since you can exercise and sell your shares freely through the public market.

In a private company, options can encourage employees to stay with the company, play a role in its future growth and have the opportunity to share in upside if the company’s stock increases in value. Often, such grants endeavor to give employees an ‘owner’s mentality’ and boost their confidence in the company’s trajectory.

Comparing and contrasting: common shares vs. preferred shares vs. SPV units vs. options

Now that each equity type has been defined, here is a breakdown of how they differ across several important dimensions:

Final thoughts

It’s important to have a solid grasp of the differences between common shares, preferred shares, SPV units and options in the private market, regardless if you’re (i) an employee receiving a potential equity stake opportunity or (ii) an investor looking to invest more wisely. These equity stakes have varying rights, risks and rewards, which can affect incentives for employees, outcomes for investors and the structure of potential company exits. Finally, company founders, employees and investors alike are well-advised to carefully examine equity agreements before making any commitments.