Stanford VC Course Highlights: The Fundamental Venture Capital Knowledge Every Founder Should Understand

Founders are most likely to lose out on liquidation preferences.

Author: Ilya Strebulaev

Translation: Deep Tide TechFlow

Deep Tide Introduction: This is the first public lecture of Stanford Business School’s VC course. The author has taught this course for many years, with over 1,300 students—500 of whom started companies, and 600 entered the VC industry.

He decided to make the full course content publicly available, starting with the most fundamental and easily misunderstood cash flow terms—convertible preferred stock, liquidation preferences, conversion rights. These terms determine how much founders can actually receive upon exit.

For founders planning to raise funds or already negotiating terms, this is essential foundational material.

Full Text:

This article will explain how cash flow terms work, how liquidation preferences affect your returns, and how convertible preferred stock can give investors an advantage.

These are basic concepts every entrepreneur should understand.

Welcome, and My Motivation

I have been teaching venture capital at Stanford Business School for many years. During this time, over 1,300 students have taken the course, about 500 of whom later founded startups, and around 600 entered the venture capital (VC) and broader private equity industry as investors. I stay in touch with many students and often receive emails or messages saying, “Once again, I pulled out your lecture notes and slides while negotiating funding or reviewing term sheets.”

I’ve always wanted to share my knowledge and experience broadly, especially because the VC and startup worlds are often shrouded in mystery and widely misunderstood. That’s also why I started posting VC research findings almost daily on LinkedIn. But to share the details of a complex and challenging course—where concepts build on each other—requires different media. So, I’m here.

After reading each article, you should have a fairly deep understanding of how investors make decisions, how entrepreneurs and investors negotiate cash flow distribution and corporate governance, and many other everyday topics in the startup world.

In the initial articles, we will go straight to the core, mainly discussing cash flow terms in Series A VC financings. Essentially, these terms are rules about “who gets what when the cake is divided.” We will learn about the most common financial securities in VC funding—convertible preferred stock. We will cover all major contractual terms that determine how proceeds are split between founders and investors. After covering Series A, we will move on to later rounds. Only then will we discuss pre-Series A instruments like SAFEs and convertible notes. Many students ask why I don’t start with SAFEs—since many founders issue those first. But the key feature of SAFEs is that they convert into securities issued later by the startup, and without understanding those securities, it’s hard to truly grasp SAFEs. After covering cash flow terms, we will discuss control, corporate governance, and conflicts of interest—absolutely critical topics. As I keep telling students, “You only lose control of your startup once. Once lost, it’s gone forever.”

A Typical Case

When explaining cash flow topics, I will use a consistent, evolving case study. Ann Zhao and Matt Smith are co-founders of SoftMet, a tech startup. During fundraising, they meet Rob Arnott, a partner at Top Gun, a top-tier VC firm. Rob later invites Ann and Matt to pitch their startup to all Top Gun partners. A week later, they receive a term sheet from Top Gun proposing:

• Top Gun invests $10 million in SoftMet.
• Top Gun receives Series A preferred stock at an original issue price (OIP) of $4 per share.
• The Series A preferred stock has a 1x liquidation preference.
• 1 share of Series A preferred stock can be converted into 1 share of common stock of SoftMet.
• The Series A preferred stock includes various additional terms and conditions.
• Founders hold 7.5 million common shares.
• Post-money valuation is $40 million.

Ann and Matt need to understand what this term sheet means: What exactly is Series A preferred stock? What is post-money valuation? What is a liquidation preference? What is conversion? Which features should they focus on? Which terms might have significant financial implications? Which might they want to renegotiate? Which terms are more founder-friendly?

We Need to Make Simplifying Assumptions to Introduce All Concepts

To keep things clear, we start with some simplified assumptions. We will relax these assumptions in later lectures—please stay tuned! Don’t dismiss this just because you think, “This ivory-tower professor doesn’t realize founders don’t just ‘hold’ shares but ‘own’ them,” etc. I know, and we will revisit all these points when appropriate.

Here are the assumptions I will consistently use in the initial VC funding lectures (if these terms are unfamiliar, that’s why we’re simplifying):

• Assumption: SoftMet does not employ any staff. This means SoftMet doesn’t need to pay employees with cash or stock, and we treat founders purely as owners, not employees. Vesting and founder employment terms will be discussed later.
• Assumption: Top Gun is SoftMet’s first external investor. In reality, most VC rounds are preceded by angel or seed rounds with different securities.
• Assumption: This round is the only investment supported by VC backing. In reality, my research shows U.S. unicorns typically raise more than six rounds of VC funding. We will relax this assumption soon.
• Assumption: Only cash flow terms matter. The term sheet also covers governance—control, voting rights, board seats—but we will address those later.

Investors Exchange Securities for Returns

Top Gun’s $10 million investment is a VC round—exchanging cash for securities. The $10 million invested is called the investment amount.

As a return, Top Gun will receive securities that give it a stake in SoftMet. Specifically, a certain number of new securities—Series A preferred stock—will be issued to Top Gun as part of this round. But how many shares will Top Gun get? How will its ownership percentage be allocated after investment? How will future proceeds be split between founders and VC investors?

The term sheet provides clues by describing different scenarios of who gets what. The number of shares Top Gun receives depends on the investment amount and the original issue price (OIP) of the Series A preferred stock. The OIP is the price paid per share at issuance, often abbreviated as OIP, or called the original purchase price (OPP).

Note: OIP differs from par value. Par value is a nominal value set in the company’s charter—arbitrarily assigned at incorporation and usually with little relation to actual valuation or economic significance. Common par values are $0.001 or $0.0001, or sometimes “no par.”

We can use the OIP to determine how many shares Top Gun receives. With an investment of $10 million and an OIP of $4, the calculation is:

• Shares = Investment amount / OIP = $10,000,000 / $4 = 2,500,000 shares.

Thus, Top Gun invests $10 million in cash and receives 2.5 million Series A preferred shares. More generally, the relationship among OIP, investment amount, and shares received is:

• Shares = Investment amount / OIP

Once you know any two of these three quantities, you can determine the third. Actual term sheets vary quite a bit in describing proposed investments, but you should always be able to deduce these three values from the given information. The SoftMet term sheet provides the investment amount and OIP. Alternatively, it might specify the investment amount and the number of shares to be issued.

Example 1: Original Issue Price

VC fund Great Innovation Partners invests $25 million in early-stage company Fox Solutions, Inc., obtaining 2 million seed round preferred shares. What is the original issue price?

• Original issue price = Investment amount / Number of shares = $25,000,000 / 2,000,000 = $12.50 per share.

Founders Usually Hold Common Stock

Early-stage founders typically hold common stock, which is the most common form of ownership in public and private companies worldwide. Stock is a form of company ownership that grants certain rights to its holders (shareholders). In other words, shareholders have claims on the company. Equity is another common term used to describe stock claims; here, we use “stock” and “equity” interchangeably. These terms distinguish these securities from another common form of company claim—debt.

In “common stock,” the word “common” is meaningful only if the company has issued other types of securities. If common stock is the only security issued by the company, then each share of stock is treated equally—only one class of claim! More generally, each share of common stock is identical to any other.

When profits are distributed, each share of common stock is entitled to the same share of the proceeds as any other common share. Therefore, profits are evenly distributed among all outstanding common shares. However, if other holders own different types of securities, profit distribution can differ significantly. In VC deals, this is almost always the case.

Investors Hold Convertible Preferred Stock

The Series A preferred stock obtained by Top Gun is an example of convertible preferred stock. This is the most common security chosen by VC investors in the U.S. It combines features of debt and equity. For aspiring entrepreneurs or early-stage investors, unfortunately, this security’s structure is complex—especially compared to traditional debt and common stock. Fortunately, we will now understand it together.

At its core, convertible preferred stock is a security that gives the holder a choice between two possible returns. The holder can choose to convert the preferred stock into another security, usually common stock (this is called the conversion feature). Or, the holder can receive a one-time payment before common shareholders get any proceeds (this is called the liquidation preference). This right often comes with many additional conditions and depends on numerous contractual provisions we will explore. But the key idea is that this security offers investors a choice between conversion and liquidation preferences.

A Very Important Point—Especially for Those with Market and Banking Experience—is that in traditional financial markets, companies sometimes issue securities called preferred stock. While superficially similar, securities issued in VC deals have many features that make them quite different from publicly traded preferred stock. If your understanding of preferred stock comes from the public markets—be aware that it’s different. Don’t skip this part.

Example 2: Preferred Stock Issued by a Public Company

In 2018, large listed insurance company MetLife issued a new series of preferred stock, MET-E, offering 28 million shares. These preferred shares function similarly to debt securities, providing investors with perpetual fixed dividends. MET-E offers a 5.63% coupon rate but no voting rights (unlike common stock). Preferred shareholders have priority over common shareholders for dividends and are paid before common shareholders, but after debt holders. These preferred shares typically do not have conversion features.

VC contracts often refer to such securities as preferred stock, but when you see “preferred stock” in VC contracts or term sheets, you can safely assume it is convertible. In my analysis of thousands of VC contracts, over 99% of “preferred stock” is actually convertible.

Although contracts often omit “convertible” in the security’s name, they usually include other descriptors. For example, the security might be called Series A preferred stock, just like the Top Gun proposed investment.

Example 3: Series Letters

Ride-sharing company Uber issued Series seed, Series A, Series B, up to Series G preferred stock during its private VC-backed phase. Big data company Palantir issued Series K preferred stock in its 2015 financing rounds (after Series A through J). SpaceX, before going public, might use all letters to name its series of preferred stock (I’m writing this in January 2026). Sometimes, companies issue securities out of order—for example, during restructuring. For instance, online gaming company Zynga issued Series A, B, and C preferred stock, then issued Series Z preferred stock just before its IPO.

Historically, Series A preferred stock was the name for the securities issued in the first VC round. Over the past fifteen years or so, the first security is often called seed preferred stock (like Uber). This usually indicates a simpler structure than full Series A preferred stock. Founders and investors may also want to signal that this is an extremely early-stage company. Once the company completes another round, it typically issues Series A preferred stock. This means you shouldn’t assume “Series A” always means the first VC round.

So, what is Series A VC funding? The best way to tell is whether this round is a priced round—that is, whether the securities have an OIP. If the company issues SAFEs or convertible notes, it’s not a priced round; but seed preferred stock is a priced round. (Note: The common misconception is that non-priced rounds do not set a valuation for the company—that’s incorrect, and we will discuss this when appropriate.)

Legal advisors providing advice to VC investors and startups are quite creative with naming, so there are many other subtle variations. Sometimes, these names also include additional series or suffixes (e.g., Series A-1, Series A-2). If they are part of the same round, these Series A-1 shares are usually only slightly different in terms of specific terms from Series A shares, often because some securities are converted into (or nearly equivalent to) Series A. Alternatively, they might belong to entirely different financing rounds—e.g., if the company believes it has not yet reached the milestones expected by the market for Series B companies.