![]() With a participating liquidation preference, investors get their minimums AND a pro-rata share of anything left over along with other shareholders. That’s called a non-participating liquidation preference. In the example above, I get the larger of the minimum guarantee (1x my original investment) OR the value of the stock. Participating vs Non-Participating Liquidation Preference Had the startup been acquired for $20M, I’d obviously take the $2M my stock was worth rather than the $1M liquidation preference. This is one of the special conditions that makes my stock “preferred”. If I invest $1 million in a startup with a $10M valuation, and it’s subsequently acquired for only $5M, if I have a 1x liquidation preference, I get my $1M back instead of the $500k my stock would otherwise be worth. However, 1.5x and 2x liquidation preferences aren’t uncommon, and I’ve even been in a deal with a 4x liquidation preference. The standard SAFE note includes a 1x liquidation preference. In most cases, the liquidation preference is “1x”, meaning the investor is guaranteed at least her money back. What is a Liquidation Preference?Īt its simplest, the liquidation preference is a minimum payout the investors receive when the company is acquired. Both founders and investors need to understand them and know what they’re agreeing to. Liquidation preferences seem like a minor detail on the term sheet, but other than the valuation, they’re probably the most important term. But without liquidation preferences, I get burned by early exits, so I depend on them to protect me, too. I’ve been burned by later investors using big liquidation preferences to grab all the gains for themselves. Personally, I hate liquidation preferences. All that from a couple of sentences in a term sheet. The liquidation preference can set investors in different rounds at each other’s throats, divide the board, and cause founders to sacrifice the employees who helped them build the business. In the vast majority of startup exits, it’s the liquidation preference that determines how much investors get, how much founders and employees get, and in many cases, whether they’ll get anything at all. When negotiating investment terms with startups, there is nothing as contentious as the liquidation preference. ![]()
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