Preferred Shares: What Startups and Investors Should Know In Australia

If you’re building an Australian startup (or investing in one), preferred shares will come up sooner than you think.

They’re a common tool in venture-style fundraising because they can balance two competing goals: giving investors enough protection to invest confidently, while still letting founders grow the business without giving away control too early.

But preferred shares can also be a source of confusion (and sometimes conflict) if the terms aren’t clearly understood or properly documented. The difference between a smooth raise and a painful cap table can come down to a few clauses.

Below, we break down what preferred shares are, how they work in Australia, the rights investors commonly ask for, and what founders should watch out for before agreeing to them. This article is general information only and not legal advice.

What Are Preferred Shares (And How Are They Different To Ordinary Shares)?

In most Australian companies, the “default” share type is ordinary shares. These usually carry standard rights like:

• voting rights (e.g. one vote per share, depending on the company’s rules),
• rights to dividends if the company declares them, and
• rights to participate in proceeds if the company is sold or wound up.

Preferred shares are a different class of shares that give the holder certain preferred rights compared to ordinary shareholders.

That preference usually shows up in situations like:

• an exit (sale of the company),
• a liquidation (winding up/insolvency), or
• future fundraising rounds (where certain protections might be triggered).

In practice, preferred shares are often issued to external investors (like angel investors, seed investors, or venture capital investors), while founders and employees hold ordinary shares (or options).

Importantly, “preferred shares” isn’t one standard package. The term is a label for a class of shares that can be customised. What matters is the actual rights attached to that class.

Can Australian Companies Issue Preferred Shares?

Yes. Australian proprietary companies can issue different classes of shares, including preferred shares, as long as the company’s governing documents allow it and the issue is properly approved and recorded.

Typically, you’ll need to think about:

• whether your Company Constitution allows different classes of shares (and the process for issuing them),
• whether shareholder approvals are required for the share issue, and
• updating your company records (including the share register), and notifying ASIC where required (for example, if there’s a change to share structure/share classes that needs to be reflected in ASIC records).

It’s common for startups to update their constitution during (or just before) a priced fundraising round to reflect the new share class and investor rights.

Why Do Startups Use Preferred Shares In Fundraising?

From a founder’s perspective, you might wonder: why not just issue ordinary shares to investors and keep everything “simple”?

The answer is that investors often want downside protection and clarity on what happens if things don’t go perfectly. Preferred shares can help with that, without forcing founders to hand over day-to-day control.

Preferred shares are commonly used to:

• reduce investor risk (e.g. through liquidation preferences),
• create a clear framework for future fundraising and exits,
• align expectations around governance and reporting, and
• set negotiation “levers” beyond price (valuation isn’t the only term that matters).

In early-stage fundraising, you’re often negotiating under uncertainty. Preferred shares can be the mechanism that gets both sides comfortable enough to move forward.

Are Preferred Shares Always Better For Investors?

Not automatically. Preferred shares can be structured in founder-friendly ways or investor-friendly ways.

Some preferred share structures provide reasonable protection (which can make funding possible). Others can be so heavy on preferences and control rights that they significantly reduce founder upside or make later rounds harder to close.

The key is understanding the terms, how they interact, and what they look like under different exit outcomes.

Common Rights Attached To Preferred Shares (In Plain English)

Preferred shares typically come with a bundle of rights. Here are some of the most common ones you’ll see in Australian startup deals.

1. Liquidation Preference

A liquidation preference sets out who gets paid first if the company is sold or wound up.

For example, a “1x non-participating liquidation preference” often means the investor gets back an amount equal to their original investment before ordinary shareholders share the remaining proceeds. After that, the investor usually chooses between:

• taking their preference amount; or
• converting to ordinary shares and taking their pro-rata share of proceeds.

This can make a big difference in a “modest exit”.

Founders sometimes focus heavily on valuation, but liquidation preference can be just as important to the final outcome.

2. Conversion Rights

Preferred shares often convert into ordinary shares automatically on certain triggers, such as:

• a qualifying IPO,
• a future fundraising round meeting a threshold, or
• with the investor’s consent.

Conversion mechanics matter because they affect voting, economics, and what happens in an exit.

3. Anti-Dilution Protection

Anti-dilution provisions protect investors if the company raises a later round at a lower valuation (a “down round”).

There are different methods, ranging from more moderate to more investor-friendly. The details determine how many extra shares an investor receives (or the effective price they’re treated as having paid).

From a founder perspective, the key is understanding the real dilution impact if growth doesn’t track as expected.

4. Dividend Rights

Preferred shares may have dividend rights that are different to ordinary shares. This could mean:

• dividends accrue at a set rate,
• dividends are payable before ordinary shareholders receive dividends, or
• dividends are only payable if declared (and sometimes “cumulative” if not paid in a period).

In many venture-backed startups, dividends aren’t actually paid (because profits are reinvested). But the dividend terms may still matter in a liquidation or exit scenario if they accrue.

5. Voting Rights And Class Votes

Some preferred shares carry votes (sometimes one vote per share, sometimes more, sometimes less). But just as important is the concept of a class vote.

A class vote means certain actions can’t be taken unless the preferred shareholders (as a class) approve them. Examples often include:

• issuing a new class of shares,
• changing the company’s constitution in a way that affects their rights,
• selling the company or key assets, or
• taking on major debt.

This is usually framed as “investor protection”, but it can also operate like a veto right over major decisions.

6. Information And Inspection Rights

Investors may ask for rights to receive regular information, such as:

• monthly or quarterly management reports,
• annual financial statements, and
• budgets or cashflow forecasts.

This is often reasonable. It’s also a good prompt for startups to improve internal reporting processes early.

7. Redemption Rights (Less Common, But Important)

Some preferred shares include a right for investors to require the company to “redeem” (buy back) their shares after a certain time.

This can create cashflow pressure if the business isn’t in a position to return capital. Redemption and share buy-backs are also subject to Corporations Act requirements (including solvency and other procedural rules), so it’s a clause founders should take seriously when it appears.

How Preferred Shares Are Set Up In Australia (What Documents You’ll Actually Need)

Preferred shares aren’t just a handshake agreement. If you’re issuing a new class of shares, you’ll want to ensure the company’s legal documents and approvals line up properly.

In many Australian startup fundraises, the core legal “stack” includes:

• Company Constitution updates: often required to create/define the rights of the preferred share class and mechanics like conversion or class votes.
• Share subscription documents: recording who is investing, how much, and what they receive.
• Shareholders agreement: setting out governance, decision-making, transfer restrictions, and investor protections (many of the practical “control” terms live here).
• Board and shareholder approvals: to properly approve the issuance and any related changes.

In other words, preferred shares are usually part of a broader deal structure, not a standalone concept.

If you’re bringing on investors (especially if there are multiple shareholders or you’re planning future rounds), it’s common to put a proper Shareholders Agreement in place so everyone is working from the same rules.

Do You Need A Special Constitution To Issue Preferred Shares?

You don’t always need an entirely new constitution, but you often need amendments. Many “off-the-shelf” constitutions are not built for venture-style preferred rights.

If you try to bolt preferred shares onto a constitution that doesn’t deal with different share classes clearly, you can end up with uncertainty around:

• how conversion works,
• how class votes are counted,
• what happens on an exit, and
• whether certain rights are enforceable.

That uncertainty is exactly what investors don’t want (and it can also hurt you in future rounds).

Founder Watch-Outs: What To Check Before You Agree To Preferred Shares

Preferred shares are not “bad” for founders. They’re often a normal part of raising capital. But there are a few common traps we see founders fall into when the focus is on closing the round quickly.

1. Don’t Look At Valuation In Isolation

Two term sheets can offer the same headline valuation but produce very different outcomes due to liquidation preferences, participation rights, anti-dilution, and veto rights.

If you’re comparing offers, it’s worth modelling a few exit scenarios (for example, a small exit, a medium exit, and a big exit) and checking how proceeds flow under the preference terms.

2. Be Clear On Control And Decision-Making

Some preferred terms give investors a say on genuinely major issues. Others give investors a veto over ordinary operational decisions, which can slow down your business.

In the early days, speed matters. If you’re building in a fast-moving space, you’ll want to ensure governance rights protect investors without stopping founders from executing.

3. Think About Future Rounds

The terms you agree to now will be read closely by your next investors.

If your first round includes very investor-friendly terms, later investors might insist those terms be renegotiated (or they may worry about messy preference stacks), which can complicate the next raise.

4. Understand How Employee Equity Will Fit In

If you plan to build a team and offer equity incentives, you’ll want to ensure the cap table and share structure can accommodate an employee option pool.

Preferred shares can interact with employee equity in a few ways (for example, exit waterfalls). It’s a good idea to think through this early, rather than trying to retrofit later.

5. Make Sure Your House Is In Order On Compliance

Investors commonly do legal due diligence before investing. If your contracts and compliance foundations are messy, it can slow down the deal or create leverage for investors to ask for tougher terms.

Depending on your business model, this might include:

• your customer-facing terms (especially for SaaS, marketplaces, or online businesses),
• your data handling and Privacy Policy, and
• your hiring approach (employees vs contractors) and appropriate agreements.

If you’re already employing staff, having a proper Employment Contract in place can help reduce risk and give investors confidence that key relationships are documented.

What Investors Usually Want From Preferred Shares (And Why)

If you’re a founder, it helps to understand the investor mindset. Most investors are not trying to “take your company”. They’re trying to manage risk.

Investors typically want preferred shares to achieve outcomes like:

• capital protection: if the startup sells early for a modest amount, they want a fair chance of getting their investment back;
• fair governance: they don’t want major structural changes (like issuing a new senior class of shares) without their consent;
• transparency: they want visibility on performance and runway; and
• certainty on exit mechanics: so there’s no ambiguity about how proceeds are distributed.

In many cases, preferred shares are also a signalling tool. They indicate that the investment is being made on terms that are understood and accepted in the venture market.

The practical goal is to land on terms that are fair, clear, and investable, without creating an overcomplicated structure that becomes difficult to manage.

Where Do Preferred Share Terms Usually Sit?

Preferred share rights can appear across multiple documents (for example, the constitution and shareholders agreement). Where they sit matters because:

• some rights need to be attached to the share class itself, and
• some rights are more appropriately handled as contractual obligations between shareholders.

This is one of the reasons founders and investors usually document rounds carefully, rather than relying on informal side letters.

Key Takeaways

• Preferred shares are a separate class of shares that give investors certain preferred rights compared to ordinary shareholders, often impacting exits, liquidation, and future fundraising.
• The most common preferred share rights include liquidation preference, conversion, anti-dilution, and special voting/class consent rights.
• Preferred shares can be a normal, healthy part of raising capital, but the terms need to be clearly understood because they can significantly affect founder outcomes.
• In Australia, issuing preferred shares usually involves aligning your constitution, shareholder approvals, and deal documents (and it often makes sense to have a clear Shareholders Agreement in place).
• Founders should look beyond valuation and check how the preferred terms play out under different exit scenarios, and how they’ll affect future rounds and employee equity.

If you’d like help structuring a fundraising round or documenting preferred shares properly, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.