Liquidation Preference

What is Liquidation Preference?

Liquidation preference determines who gets paid first (and how much) when a company is sold or liquidated. Investors with liquidation preference get their money back before common shareholders receive anything.

A 1x liquidation preference means investors get their investment back first. A 2x preference means they get double their investment before others are paid.

Why Liquidation Preference Matters

In a successful exit, liquidation preference often doesn't matter because everyone does well. But in a modest exit or down sale, it determines whether founders and employees get anything.

If investors put in $10M with 1x preference and the company sells for $12M, investors get $10M and everyone else splits $2M. Without preference, it would be split by ownership percentage.

Types of Liquidation Preference

Non-participating: Investors choose preference OR convert to common (most founder-friendly). Participating: Investors get preference AND their pro-rata share of what's left (investor-friendly). Capped participating: Participating up to a maximum return multiple.

Exit scenario with 1x non-participating preference:

• Series A invested: $5M for 25%
• Company sells for: $15M

Option A (take preference): $5M

Option B (convert to common): 25% × $15M = $3.75M

Investor takes the $5M preference. Remaining $10M goes to other shareholders.

If sale was $30M: Convert for $7.5M beats the $5M preference.