Ask the attorney: How founder friendly is FF stock?

(Editor’s note: “Ask the Attorney” is a weekly VentureBeat feature allowing start-up owners to get answers to their legal questions. Submit yours in the comments below and look for answers in the coming weeks. Author Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a boutique corporate law firm specializing in the representation of entrepreneurs.)
Question: I’m launching a new venture and read your VentureBeat post a few weeks ago about Class F stock.  I’m a little confused because I asked around, and none of my friends who are founders had heard of it.  One guy did mention Series FF stock, but I wasn’t sure if that’s the same as Class F?  Please let me know.
Answer: Yes, it’s definitely confusing – but “Class F” stock and “Series FF” stock are different.
As I previously discussed, Class F stock is a separate class of common stock that was designed in 2009 by The Founder Institute to provide founders with certain special rights (e.g., super-voting rights) upon incorporation.  The articulated goal is to level the playing field for founders in connection with their negotiations with investors.
Series FF stock, on the other hand, is a separate class of preferred (not common) stock that was designed in 2006 by Sean Parker of the Founders Fund to permit founders to cash out a small percentage of their stock prior to a liquidation event.  (The “FF” stands for Founders Fund, and Series FF stock has been used in several Founders Fund deals.)
Here’s how Series FF stock works:
1)      Shares of Series FF preferred stock are generally issued to the founders upon incorporation or immediately prior to the Series A round.
2)      The shares are generally identical to shares of common stock, except they are  convertible at the shareholder’s option into shares of the same series of preferred stock issued in a later round (provided that the buyer of the Series FF shares purchases them as part of that round and pays the same price as the preferred stock being issued).
3)      The conversion of the shares of Series FF stock must be approved by the issuer’s Board of Directors.
As noted above, the significant advantage of these shares is they allow the founder(s) to take a few chips off the table.  For many founders, the opportunity to cash-out is quite appealing, particularly where they have run-up significant credit card debt and/or are interested in buying a home for their family.  The amount of the cash-out, however, is generally capped to between 10 and 15 percent (depending upon the round of financing).
The other advantage is it is a clever way of avoiding issues relating to the increased pricing of options if investors were to buy founders’ common stock, as opposed to preferred stock (converted from the Series FF).
The significant disadvantage of issuing Series FF stock, as you might guess, is it may deter investors, who generally want founders to be “all in” when it comes to the venture.  (There are circumstances where founders are permitted to take some money out, but usually it’s done through a mechanism other than Series FF stock.)
Other disadvantages include an added layer of complexity (meaning higher legal fees, among other things) and potential litigation from other stockholders (including employees of the company) if the company doesn’t have a successful exit.  If it does come to a point of litigation, the founders and/or the Board of Directors may find it difficult to justify having investment funds arguably diverted from the company.
Series FF stock (like Class F stock) is relatively new and its issuance is not widespread.  For first-time entrepreneurs, it probably makes sense to keep it simple and just issue ordinary shares of common stock.  But it’s definitely nice to see any sort of effort that helps founders better align their interests with their investors.
Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  VentureBeat, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.
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