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

Author: Ilya Strebulaev

Translation: Deep Tide TechFlow

Deep Tide Introduction: This is the first public lecture note of Stanford Graduate School of Business VC course. The instructor 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 open the full course content to the public, starting from the most basic and easily pitfalls—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, this is essential foundational material.

The full text is as follows:

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

These are fundamental concepts every entrepreneur should understand.

Welcome, and my motivation

I have been teaching venture capital at Stanford Graduate School of Business for many years. During this time, over 1,300 students have taken this course, about 500 of whom later founded startups, and about 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 they “revisit your lecture notes and slides from your course when negotiating term sheets or fundraising.”

I have 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 publishing VC research findings almost daily on LinkedIn. But sharing detailed, complex, and layered concepts from this course requires different media. So, I am 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 countless other daily matters in the startup world.

In the initial articles, we will directly focus on core topics, mainly discussing cash flow terms in Series A VC financings. Essentially, these terms are rules about “who gets what when dividing the cake.” 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 be ready to discuss pre-Series A VC securities, including SAFEs and convertible notes. Many students ask me why I don’t start with SAFEs—after all, they are among the first securities many founders issue today. 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 rights, corporate governance, and conflicts of interest in startups. These are absolutely critical topics. As I keep telling students, “You only lose control of your startup once. Once lost, it’s gone forever.”

Typical case

When explaining cash flow topics, I will use a recurring case study that evolves with the content. 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 present their startup idea to all Top Gun partners. A week later, founders receive a term sheet from Top Gun. The term sheet proposes:

Top Gun invests $10 million in SoftMet.

Top Gun receives Series A preferred stock at an original issue price (OIP) of $4 per share.

Series A preferred stock has a 1x liquidation preference.

One share of Series A preferred stock can be converted into one share of SoftMet common stock.

Series A preferred stock comes with 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 pay particular attention to? Which terms might have significant financial implications, prompting renegotiation? Which are more founder-friendly?

We need to make some simplified assumptions to introduce all concepts

To keep things clear, we will start with some simplified assumptions. These will be relaxed in later lectures—please stay tuned! Don’t dismiss this just because you think “this ivory-tower professor doesn’t understand founders’ ‘ownership’ versus ‘equity’ etc.” I know, and we will revisit all these points at the appropriate time.

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

Assumption: SoftMet does not employ any staff. This means SoftMet does not 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 SoftMet raises as a privately supported VC-backed company. In reality, my research shows that 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 corporate governance—control rights, voting rights, board seats—but we will address these later.

Investors exchange securities for investment returns

Top Gun’s $10 million investment is a VC round—exchanging cash for securities. The $10 million 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 as part of this round and allocated to Top Gun. But how many shares will Top Gun get? What will be its ownership percentage after investment? How will future proceeds be split between founders and VC investors?

The term sheet provides clues by describing who gets what under different scenarios. The number of shares Top Gun receives depends on the investment amount and the original issue price (OIP) of 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 corporate charter, arbitrarily assigned at incorporation, with little relation to the company’s actual valuation and no real economic significance. Common par values are $0.001 or $0.0001, or sometimes “no par.”

We can use OIP to determine how many shares Top Gun gets. With an investment of $10 million and an OIP of $4, Top Gun’s share count is:

Therefore, Top Gun invests $10 million in SoftMet to acquire 2.5 million Series A preferred shares. More generally, the relationship among OIP, investment amount, and shares received by the investor is:

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 infer these three 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 the investor receives.

Example 1: Original issue price

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

The original issue price is:

In other words, Great Innovation paid $12.50 per seed preferred 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 for stock claims, and here we use “stock” and “equity” interchangeably. These terms also distinguish these securities from another common form of company claim—debt.

In “common stock,” adding “common” only makes sense if other types of securities are issued by the same company. If common stock is the only security issued, then each share of the company’s stock is treated equally—only one type of claim! More generally, each share of common stock is treated identically 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. But 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 acquired by Top Gun is an example of convertible preferred stock. Convertible preferred stock is the most common security chosen by VC investors in the U.S. This security combines features of debt and common 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 master it together now.

At its core, convertible preferred stock is a financial security that gives the holder a choice between two possible return options. 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 the liquidation preference feature). This right often comes with many additional conditions and depends on numerous contractual terms we will explore. But the core idea is that this security offers investors a choice between conversion and liquidation preferences.

A very important point—especially for those with experience in stock markets and investment banking—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 public-market preferred stock. If you understand preferred stock from the public markets—this is 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 to the market. 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 (but after debt holders). These preferred shares typically do not have conversion features.

VC contracts usually 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 also 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 qualifiers. For example, the security might be named Series A preferred stock, just like the proposed investment in Top Gun.

Example 3: Series letter naming

Ride-sharing company Uber, during its private VC-supported phase, issued Series seed, Series A, Series B, up to Series G preferred stock. Big data analytics firm Palantir issued Series K preferred stock in its 2015 financing round (after Series A through J). SpaceX, before its final IPO, is likely to exhaust all alphabet letters to name its series of preferred stock (I am writing this in January 2026). Sometimes, companies issue securities out of order, e.g., during restructuring. For example, online gaming company Zynga issued Series A, B, and C preferred stock, then skipped to Series Z before its IPO.

Historically, Series A preferred stock was the name for securities issued in the first VC round. Over the past roughly fifteen years, the first security is often called seed preferred stock (like Uber’s case). 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 financing? The best way to judge 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. This is incorrect, and we will discuss it when appropriate.)

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