A liquidation preference determines the order and amount of payments on a sale
or liquidation, and it frequently matters more than ownership percentages.
Non-participating preferred. The holder receives the greater of its
preference or what it would receive on conversion to common. This is the market
standard in most venture financings.
Participating preferred. The holder receives its preference and then shares
in the remainder as if converted — a double dip. Frequently capped at a multiple
of the investment, after which conversion becomes more favorable.
Multiple. One times the investment is standard; higher multiples appear in
down rounds and distressed financings and substantially reduce common proceeds.
Accruing dividends added to the preference, compounding over time and often
overlooked in exit modeling.
Seniority. Whether later rounds rank ahead of earlier ones, or pari passu.
Stacked seniority in a modest exit can leave earlier investors and common
holders with nothing.
Deemed liquidation. Whether a sale of the company, a merger or an asset sale
triggers the preference, which it almost always does by definition.
Modeling. The only way to understand a capitalization table with
preferences is to run exit scenarios across a range of values. Percentage
ownership is not informative on its own.
