Liquidation preferences: who gets paid first when you sell.
Preferred investors usually get their money back before common holders in a sale. The preference decides how much they take first and whether they share in the rest.
The short answer
A 1x non-participating preference, the common default, lets an investor take either their money back or their percentage of the sale, whichever is higher. Participating preferences let them take both. Multiples above 1x add even more to the front of the line.
Example: $12M sale, investor put in $5M for 25%, 1x non-participating
$7M goes to founders and common holders
Example arithmetic only. 25% of $12M is $3M, so the investor takes the $5M preference instead.
- Common holders $7M: 58%
- Investor preference $5M: 42%
Compare the options
Investor gets
1x non-participating: Money back or their share, whichever is more
1x participating: Money back and then their share of the rest
$12M sale in the example
1x non-participating: $5M to investor, $7M to common
1x participating: $5M plus 25% of $7M: $6.75M to investor
Common holders get
1x non-participating: $7M
1x participating: $5.25M
Founder-friendly
1x non-participating: Yes; the common default
1x participating: Less so; sometimes capped
Why the preference matters in modest outcomes
In a large sale, a non-participating investor converts to common and takes their percentage, so the preference does not bite. It matters when the company sells for less than the investors' combined preferences divided by their stakes. In that range, preferred holders are paid first and founders can receive far less than their percentage suggests.
Stacking across rounds
Each round adds its own preference. They can be paid in order of seniority, with the latest round first, or side by side as equals, called pari passu. The more you raise, the larger the stack ahead of common, so keep total preferences in view when you weigh a bigger round.
- Is the preference 1x, or a multiple?
- Is it participating, and if so, is participation capped?
- Is it senior to earlier rounds or pari passu?
- What does the total stack look like at a modest sale price?
Terms to know
Liquidation preference
An investor's right to be paid back before common holders in a sale.
Participation
Taking the preference and also sharing in what remains.
Pari passu
Paid side by side, in proportion, rather than in order.
Does your deck earn you clean terms?
Investors ask for heavier preferences when they see more risk. Upload your deck and we show you where the risk looks highest to a reader.
Questions founders ask
Do SAFEs have a liquidation preference?
Before conversion, a SAFE generally gets its money back or its as-converted amount in a sale, whichever is higher. After conversion, SAFE holders hold the preferred stock of that round, with its preference.
Is a 2x preference ever reasonable?
It shows up in difficult markets or rescue rounds. It shifts a lot of value away from common holders, so model the payout at several sale prices before agreeing.
Sources
Sources: industry model venture financing documents; standard US practice. Not legal or financial advice.
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