Fundraising
Liquidation preference
The right of preferred-share investors to receive their investment back (often with a multiplier) before common shareholders receive anything when the company is sold or liquidated.
In plain English
Investor put in $10M at a 1× non-participating liquidation preference. Company sells for $30M. The investor gets the first $10M back (or 33% of $30M, whichever is greater); founders and employees share the rest. With a 2× preference, the investor takes the first $20M.
Example
Investor: $5M at 1× non-participating preference, 25% ownership. Company sells for $15M. Investor takes max($5M from preference, 25% of $15M = $3.75M) = $5M. Founders/common share remaining $10M. If the sale price had been $25M, the investor would have taken 25% × $25M = $6.25M (more than preference).
Why it matters
Liquidation preferences flip the economics of small/medium exits. Founders often see 'we own 60%' and assume they'll capture 60% of the sale. After multiple rounds with stacked preferences, founders can net zero on a $50M exit if total preferences exceed sale price.
Common mistakes
- Accepting >1× preference — only justified by genuinely high valuation negotiation; 2x+ is increasingly aggressive
- Accepting participating preference — investor takes preference AND pro-rata share of remaining (double-dip)
- Not modelling preference stack across all rounds — preferences are cumulative and seniority matters
- Confusing preference with veto rights or board control (separate provisions)