Liquidation Preference
A term that determines how proceeds are distributed when a company is sold, ensuring investors get paid before common shareholders.
Liquidation preference defines the payout order when a company is sold, merged, or liquidated. The standard "1x non-participating" preference means the investor gets their money back before common shareholders receive anything. If the investor put in $5M with a 1x preference, they get at least $5M from any exit, or their pro rata share of the proceeds if that is higher.
The variations matter enormously. A "participating" liquidation preference lets the investor get their money back first AND participate in the remaining proceeds proportionally. This effectively lets the investor double-dip and can significantly reduce what founders and employees receive. Participating preferences are considered founder-unfriendly and have become less common in recent years.
Multiples above 1x (like 2x or 3x) are rare in healthy markets but can appear in down rounds or distressed fundraises. A 2x preference means the investor gets twice their investment back before anyone else. In an acqui-hire or small exit, liquidation preferences can mean that common shareholders (founders and employees) receive nothing, even if the company sells for millions.
Example
A company raised $10M with a 1x non-participating liquidation preference and investors own 30%. If the company sells for $20M, investors choose between their $10M preference or their 30% share ($6M). They take the $10M preference. The remaining $10M goes to common shareholders. If the exit were $50M, they would take their 30% ($15M) instead, since it exceeds the $10M preference.
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