Liquidation Preference

The liquidation preference is a preferential right that grants investors a preferred share of the proceeds in the event of a sale or liquidation of the company. Before distribution to the common shareholders, the preferred investor first receives back the capital invested, often as a multiple. It is a central protective instrument in growth financing.

A distinction is essentially made between non-participating and participating liquidation preferences. In the non-participating variant, the investor receives either the preference or its pro-rata share, whichever is higher. In the participating variant, the investor receives both, which is considerably less favourable for the founders. A factor (such as 1x or 2x) is often agreed. In the Series A, the 1x non-participating preference is the market standard today.

The exact structure is negotiated in the term sheet and recorded in the shareholders' agreement. Its effect on the distribution of proceeds can only be modelled precisely using the cap table.