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Liquidation Preference
The order and amount investors receive in a sale or liquidation event, before common shareholders get anything.
Formula
1x Non-Participating Example:
- Investment: $5M at 1x preference
- Exit: $20M
- Investor choice: Take $5M OR convert to 25% ownership ($5M)
- Investor takes conversion: $5M
1x Participating Example:
- Same terms, investor gets $5M + 25% of $15M = $8.75M
Definition
What is Liquidation Preference?
Liquidation preference determines payout order in an exit. Investors with preference get their money back (often 1x their investment) before common shareholders receive anything.
Types of Preferences
Non-participating: Investors choose preference OR conversion to common. Participating: Investors get preference AND share in remaining proceeds. Participating preferred is more investor-favorable.
Why It Matters
In down exits, liquidation preference can mean founders and employees get nothing while investors recover capital. Stack multiple rounds of participating preferred and the math gets ugly fast.
Example
Company sells for $10M with:
- Series A: $3M at 1x participating
- Series B: $5M at 1x participating
- Common: 60% ownership
Waterfall:
- Series B gets $5M (preference)
- Series A gets $3M (preference)
- Remaining $2M split by ownership
Common shareholders get 60% of $2M = $1.2M
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