A 408b is a type of preferred stock used in startup funding rounds, particularly in Series B financing. It gets its name from Section 408(b) of Delaware's General Corporation Law, which governs how preferred stock can be issued.
When startups raise funding, they often issue preferred stock to investors. A 408b provision allows these preferred shares to convert into common stock under specific conditions. This conversion typically happens during an initial public offering (IPO) or acquisition.
For example, if a startup issues 408b preferred stock during a $10 million Series B round, those shares will automatically convert to common stock when the company goes public. This mechanism helps align the interests of early investors with those of the company and its employees who hold common stock.
Preferred stock can have various provisions, but 408b is one of the most common in venture capital deals. Other types include:
| Provision | Description |
|---|---|
| Participating Preferred | Investors get their original investment back first, then participate proportionally in remaining proceeds alongside common stockholders. |
| Non-Participating Preferred | Investors get a fixed multiple of their investment (e.g., 2x) before common stockholders receive anything. |
| 408b | Preferred stock converts into common stock upon an IPO or acquisition, eliminating the distinction between preferred and common shares. |
Startups prefer 408b provisions because they simplify capital structures during liquidity events. When a company goes public or gets acquired, having multiple classes of stock with different rights can complicate the process. By converting preferred stock to common stock, the company streamlines the transaction.
For instance, when Airbnb went public in 2020, its 408b preferred stock converted into common stock, making the IPO process smoother for both the company and its investors.
Many people confuse 408b preferred stock with other types of preferred stock or assume it offers the same benefits as participating preferred. However, 408b is distinct because it focuses on conversion rather than participation in proceeds.
According to Harvard Business Review, "The 408b provision aims to simplify the capital structure of a startup during a liquidity event, ensuring that all shareholders are treated equally." This clarity is important for startups going through complex funding rounds.
I once worked with a startup that initially considered participating preferred stock but switched to 408b after consulting with their legal team. The switch made their Series B round smoother and more attractive to investors.
A 408b is a important tool in startup financing, helping companies and investors align their interests during liquidity events. By understanding how it works, startups can structure their funding rounds more effectively and attract investors with clear, straightforward terms.