Liquidation Preferences

A liquidation preference acts as a downside protection mechanism for investors. In a sale, merger, or liquidation, it guarantees the investor receives a certain amount of money back before common shareholders (founders and employees) see a dime.

The Components

• The Multiple: Usually 1x. If an investor put in $5M, they get $5M back first. A 2x multiple means they get $10M back first.
• Participation:
  • Non-Participating (Standard): The investor chooses to EITHER take their preference amount OR convert their shares to common and take their ownership percentage of the total exit. They will choose whichever number is higher.
  • Participating (Punitive): The investor gets their preference amount back FIRST, AND THEN converts their shares to take their percentage of whatever money is left over ("double dipping").

Worked Example

Imagine a $10M investment for 20% of the company. The company sells for $30M.

Structure	Investor Return	Founder/Common Return
1x Non-Participating	$10M (takes 1x pref over 20% of $30M=$6M)	$20M
1x Participating	$14M ($10M pref + 20% of remaining $20M)	$16M
2x Participating	$22M ($20M pref + 20% of remaining $10M)	$8M

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