Dividends

You’re reading an excerpt of The Holloway Guide to Raising Venture Capital, a book by Andy Sparks and over 55 other contributors. A current and comprehensive resource for entrepreneurs, with technical detail, practical knowledge, real-world scenarios, and pitfalls to avoid. Purchase the book to support the author and the ad-free Holloway reading experience. You get instant digital access, over 770 links and references, commentary and future updates, and a high-quality PDF download.

​Definition​ A dividend is a distribution of a company’s profit to shareholders. Preferred stock pays predetermined dividends,* while a company’s board of directors must authorize any dividends to holders of common stock.* Many established public companies and some private companies pay dividends on common stock, but this is rare among startups and companies focused on rapid growth.* Startups rarely pay dividends on common stock because they generally prefer to reinvest their profits into expanding the business.

​caution​ Companies backed by traditional venture capital firms will almost certainly not ever issue dividends. Because of this, most founders don’t negotiate on dividend rights in term sheets. Venture capitalists are looking for fund-returning results, not 6–8% dividends. Negotiating on dividend terms at the Series A can be hazardous, as the company may inadvertently signal that they’re interested in becoming a cash-flow positive dividend-distributing business, not a venture-scale fund returner.

Dividends come in two major types: non-cumulative dividends and cumulative dividends.

1. A non-cumulative dividend can be declared by the board and distributed to shareholders at any time. They are most common in venture-backed companies. Non-cumulative dividends are sometimes referred to as “if, when and as” or “when, as and if” dividends. This comes straight from the language you’ll find in term sheets related to dividends: “…if, when and as declared by the Board.” Some non-cumulative dividends require the company to pay some percentage to preferred stockholders before any dividend is issued to common stockholders, which can become onerous if a venture-backed company should switch strategies to become a cash-flow positive dividend-distributing business.

2. A cumulative dividend accrues at roughly 6–8% annually to be paid out on M&A or an IPO and are essentially a guaranteed return on investment. They are much more common in private equity or hedge-fund style investments.