Convertible Preferred Share
A convertible preferred share is a company share that grants investors preferential repayment rights and can additionally be converted into a common share. It is the typical financing instrument used in large funding rounds of technology start-ups.
Anyone who invests money in a young company wants two things at the same time: protection in case the company fails, and the chance of a large profit if it succeeds. A convertible preferred share combines both in a single share certificate. It is not an ordinary share — it grants the holder special rights that ordinary shareholders do not have. At the same time, it can later be exchanged for an ordinary share, in other words “converted.” This is exactly why it is called a convertible preferred share: “preferred” stands for the special rights, “convertible” for the exchange option.
Why start-ups are financed with it
Investors who get in early on a start-up take on high risk. Most start-ups fail. Without special protection, an investor would come away empty-handed in the event of a bankruptcy — just like everyone else. The convertible preferred share solves this problem with what is known as a liquidation preference.
The liquidation preference means: if the company is sold or wound down, the holders of convertible preferred shares get their invested money back first — before anyone else receives anything. Only afterward is what remains divided among the ordinary shareholders. This preference makes the investment significantly safer. For founders this is acceptable, because in return the company gets the capital it needs to grow in the first place.
How conversion into an ordinary share works
When the convertible preferred share is purchased, a conversion ratio is set — for example: one convertible preferred share equals one ordinary share. Later, often at the company’s IPO, the investor can decide whether to convert their preferred shares into ordinary shares. This process is called conversion.
Why would anyone voluntarily give up their special rights? Because it can be worthwhile if the company is very successful. For example, if an investor invested 10 million euros at a valuation of 100 million euros and the company is later sold for 2 billion euros, converting into ordinary shares yields significantly more than the guaranteed repayment of the original amount. The investor therefore always chooses whichever option is more profitable for them.
If the investor decides against conversion, they keep the liquidation preference. They then collect their money back first and no longer benefit from further growth. This choice between the two options is the core of the instrument: downside protection, upside participation.
Convertible preferred shares in tech news and funding rounds
When the media report on a start-up’s large funding round — such as “Company X raises 500 million dollars in a Series C round” — it is almost always convertible preferred shares that are involved. In Silicon Valley they are the industry standard. European tech companies such as Zalando or Delivery Hero also used this instrument in their early stages.
At the IPO (Initial Public Offering, i.e. the first listing on a stock exchange), all outstanding convertible preferred shares are typically automatically converted into ordinary shares. After that there are no more special rights — all shareholders stand on equal footing. This moment marks the end of the start-up phase and entry into the public capital market.
It is important to know the difference from a convertible bond: a convertible bond is a loan that can be converted into shares. The convertible preferred share is a company share from the very start — not a loan. Anyone who confuses the two terms in articles draws the wrong conclusions about investors' rights and risks.