Dividends are a payout (in money or shares of stock) to Investors based on their current holdings of stock in the Company. Dividends are not mandatory and are generally not paid by startups, since they are likely not yet turning a profit. The Model NVCA Term Sheet provides for three alternatives related to dividends:
Alternative 1 (Company-friendly): Dividends paid on Preferred Stock only when also paid to Common Stock. This is a Company-friendly option, as it creates no obligation to pay dividends and provides no additional benefit to preferred stockholders over common stockholders.
Alternative 2 (Middle ground): Non-cumulative dividends paid at the Series A price, but only when the Board of Directors declares them. This is a middle-ground approach because it pegs the amount of the dividends payable, but still leaves the distribution of dividends up to the Board and doesn’t create any future obligation to preferred stockholders.
Alternative 3 (Investor-friendly): Cumulative dividends accrue at an applicable rate over time and are paid either when declared by the Board or upon liquidation of the Company or redemption of the stock. This is a very Investor-friendly option as it requires the Company to pay the Investors an increasing return over time, that also incrementally reduces the potential payout to other stockholders upon liquidation of the Company.