As a general proposition, with respect to dividends in venture capital style preferred stock, there are two main choices and a third that is rarely; but not never, seen, that is easy to comprehend and then there is a fourth choice that is rarely, seen and is hard to understand, but occurs with some frequency.

You might ask, "What is it?" But, before we go and make our visit, let’s do a quick review of the dividend provisions that are more commonly seen.

First, there are venture capital preferred stocks that do not bear dividends. That is easy, they just don’t have dividends. This is true of approximately [50%] of all deals done in New England. Even the VCs don’t seem to know this fact. I once negotiated a deal with a VC from a name brand fund who asserted that all [he said "all" not "most" or "a majority" or anything else: "all".] his firm’s deals had dividends. Of course, I could not resist, so I checked. It was about half. Make no mistake about it. Dividends are just a way of grossing up the return to the investor. They are about economics: it is as simple and as complex as that.

Second, there are venture capital preferred stocks that bear dividends that accrue and cumulate. These dividends are not actually paid until the business is sold. They just keep adding up year after year. These dividends are not usually converted in the event of an IPO (so, the economic value of the dividend is lost in that exit scenario – why is something I will go into at another time). When a liquidation event occurs (and by liquidation event I mean a sale of the business) the dividends get paid. These dividends do not compound (compounding is different from cumulating). To put a really fine point on it: If you have $1,000,000 of Series A Preferred Stock with a 10% (way too high but easy to calculate for the purposes of a blog post) and a 1x liquidation preference and you sell the business three years after the issuance of the Series A Preferred Stock, the holders of your Series A Preferred Stock get $1,300,000 as their preference. Each year the dividend accrued (it was not paid) and for three years the dividend cumulated (it added up each year). Note, the dividend did not compound.

Third, I have (very rarely) seen a dividend that gets paid on a quarterly (or semiannual basis). This is not typical. In the situations I have seen it, the reason for it is that the investor is a leveraged fund that must pay interest to its debt source and needs cash flow from investments to make these payments. Don’t worry about this situation; it almost never arises.

Fourth (and here is the odd one), sometimes you see this language or its equivalent:

"Accruing dividends will accrue from day to day, whether or not declared, and shall be non-cumulative…."

What is an "accruing non-cumulative dividend" you might ask? Let’s go back to my example of the $1,000,000 preferred with the 10% dividend. In this case (case number four), the dividend accrues but it does not cumulate. So, when you sell the company on the third anniversary of the sale of the preferred stock, the holders of the preferred stock get $1,100,000 (not $1,300,000). This is because the dividends, which accrued over the course of each year, did not cumulate across the three years.

I suppose the parties could have negotiated this result, but I suspect that what they really meant to agree upon was that the dividends would not compound. (By they way, I don’t recall ever seeing compound dividends – not that it can’t happen; I just don’t recall ever seeing it.)

All in all, don’t be shy about negotiating for no dividends, but in any event, know what you did negotiate.