Many entrepreneurs dream of the day when an investor will infuse the venture with much-needed cash, either to get started or to grow the business. One of the most common forms of investment vehicles is for the entrepreneur's company to sell preferred equity to investors.

First, a quick primer. To keep things simple, let's agree that there are two kinds of equity or stock in a corporation: common and preferred. Common stock is simply a share of ownership in the company with few if any special privileges. Preferred stock carries with it unique preferences above and beyond the privileges of common stock holders.

Paul Allen, the founder of companies such as Infobases, MyFamily (now Generations Network), and now World Vital Records, often says that the most startling day of his business career was when he learned the difference between preferred and common stock.

Why would that be so earth-shaking? Well, how about waking up one day to find that your company sells for millions of dollars but you, the founder, get nothing.

Can that really happen? Yes, it can. And it does.

Preferred stock is what venture capitalists and seasoned angel investors will generally purchase when they buy straight equity in your company. The normal procedure is that you will either open a round of investment selling preferred stock or the investors will present you with a term sheet for putting together a preferred stock purchase agreement.

Preferred stock has preferences in certain situations and events. There are more than 30 distinct points of preferential treatments that can be given preferred stock. I am going to focus on what I consider the most important preferences, with details that are negotiable. There are many others that are standard inclusions and are usually not negotiable.

Participating vs. non-participating — If preferred stock is "participating preferred," the preferred stock is converted to common stock after the liquidation preference. Preferred shareholders then share with common shareholders in divvying up the remaining proceeds. This is sometimes considered double-dipping but is almost universally an included right.

Conversion to common — In the event the preferred stock converts to common, at what rate does it convert? Frequently it's a one-to-one ratio. But, I have seen as high as 10:1, and all points in between. This means that when the common stock money is divvied up, preferred stockholders could double-dip at a ballooned share count.

First rights and pre-emptive rights — Preferred investors want to make sure you don't bring any lunatics into the fold or that you don't dilute the value of their shares by issuing cheap stock. They can protect themselves by having first rights to any shares the founders want to sell or any new issues of stock by the company. Preferred investors can control things when they have these rights.