Full Definition
A liquidation preference determines the payout order and amount that preferred shareholders (typically investors) receive before common shareholders in a liquidation event, such as an acquisition, merger, or wind-down of the company.
Types of Liquidation Preference
- 1x Non-Participating: Investor gets their money back OR converts to common stock (standard and founder-friendly)
- 1x Participating: Investor gets their money back AND shares in remaining proceeds ("double dip")
- 2x or 3x: Investor gets 2x or 3x their investment before common shareholders receive anything
Impact on Founders
Liquidation preferences can dramatically affect founder payouts in exit scenarios, especially when exit values are lower than expected. A 2x participating preference on a $10M investment means investors get $20M back before founders see anything.
Liquidation Preference Types Compared
| Feature | 1x Non-Participating | 1x Participating | 2x Non-Participating |
|---|---|---|---|
| Investor gets money back first? | Yes | Yes | Yes (2x) |
| Also shares in remaining? | No (chooses one) | Yes (double dip) | No (chooses one) |
| Founder-friendly? | Most friendly | Least friendly | Unfavorable |
| Common in? | Seed & Series A | Later rounds / distressed | Rare / aggressive terms |
Real-World Example
An investor with 1x non-participating liquidation preference on a $5M investment in a $15M exit can either take $5M or convert to common stock for their pro-rata share.
Frequently Asked Questions
What is a 1x liquidation preference?
What does participating vs non-participating mean?
Related Terms
A class of shares with special rights and preferences over common stock, typically held by investors.
A non-binding document outlining the key terms and conditions of a proposed investment deal.
A planned approach for founders and investors to realize returns on their investment in a company.
Protection for investors that adjusts their equity if the company raises money at a lower valuation.
A model showing how exit proceeds would be distributed to each class of shareholders in various scenarios.
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