Mandatory or voluntary conversion to common stock

Preferred shares from a financing round generally provide for two conversion mechanisms into common stock. Mandatory conversion typically applies upon a single-class IPO, where all preferred shares automatically convert into common stock to satisfy listing requirements.

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Voluntary conversion, conversely, is a one-way option exercised solely at the investor's initiative, when common stock becomes more advantageous to them than their preferred shares, for example following an ordinary dividend distribution more generous than their Dividend preference.

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This choice is never trivial: converting voluntarily means permanently giving up a Non-participating liquidation preference or Participating liquidation preference, in favour of a plain pro-rata share in common stock. An investor therefore only exercises this option when the math is strictly in their favour, typically when the exit value is so high that the common-stock share exceeds the amount guaranteed by their liquidation preference.

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For a founder structuring a round's share classes, precisely documenting the triggers for each of these two conversion forms in the bylaws and shareholders' agreement keeps the cap table legible at exit, a technical point any financial structuring of a term sheet must lock down.