What is a Liquidation Preference?
Liquidation Preference
Liquidation Preference is a protective legal clause in a term sheet that determines the order and amount of payout to preferred shareholders relative to common shareholders in an exit.
Why It Matters for Startups
Governs the legal rights and ownership distribution of the entity; configuring Liquidation Preference is critical for managing long-term cap table health and alignment during exit distribution payouts and deal structure parameters.
Detailed Deep Dive
Liquidation Preference is a protective legal clause in a term sheet that determines the order and amount of payout to preferred shareholders (investors) relative to common shareholders (founders and employees) in an exit event (like a sale or liquidation). A standard "1x non-participating" liquidation preference ensures investors get their initial investment back first, or can convert their preferred shares to common to share proportionally.
Frequently Asked Questions
Q:What is a Liquidation Preference and how does it affect founder payouts?
Liquidation Preference is a contract clause establishing that preferred stock investors get paid back first in an exit. A higher preference (e.g., 2x or 3x) or participating preference can dramatically reduce the cash left over for common stock holders like founders.
Q:What is participating liquidation preference?
An investor-friendly term where the investor gets their initial investment back *and* shares in the remaining proceeds alongside common holders.
Quick Facts
- CategoryLegal
- Key ApplicationExit distribution payouts and deal structure parameters
Coverage Trend12 Weeks
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