Full Definition
A waterfall analysis (or distribution waterfall) is a financial model that shows how the proceeds from a company exit (acquisition, IPO, or liquidation) would be distributed among all shareholders, taking into account liquidation preferences, participation rights, and conversion options for each share class.
Distribution Order (Typical)
- Senior preferred stockholders (latest round first)
- Junior preferred stockholders (earlier rounds)
- Participating preferred "double dip" (if applicable)
- Common stockholders (founders, employees)
Why Waterfall Analysis Matters
Understanding the waterfall is crucial for founders to know what they would actually receive in different exit scenarios. A $50M exit might sound great, but if there are $30M in liquidation preferences with participating preferred, the founders' payout could be much smaller than expected.
Real-World Example
In a $40M exit with $15M in 1x non-participating liquidation preferences, investors choose to convert to common stock (their 30% = $12M) rather than take their $15M preference.
Related Terms
The right of preferred shareholders to be paid before common shareholders in a liquidation event.
A class of shares with special rights and preferences over common stock, typically held by investors.
A planned approach for founders and investors to realize returns on their investment in a company.
A spreadsheet showing the equity ownership, dilution, and value of shares in a company.
The reduction in existing shareholders' ownership percentage when new shares are issued.
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