Liquidation Preference
The order and amount in which investors receive proceeds when a company is sold, liquidated, or dissolved.
Definition
Liquidation preference determines the priority and amount investors receive in an exit event before other shareholders. It ensures that certain investors (typically preferred stockholders) get paid before common stockholders, often guaranteeing they receive at least their original investment back.
Types and Structure
- • 1x Non-Participating: Get investment back or pro rata share, whichever is higher
- • 1x Participating: Get investment back plus pro rata share of remaining
- • Multiple (2x, 3x): Get multiple of investment back
- • Cumulative: Applies across all preferred share classes
- • Capped Participation: Participation limited to certain multiple
Real-World Example
Exit Scenario: VC invested $5M with 2x liquidation preference in company sold for $20M
VC receives $10M (2x their investment) first, then remaining $10M is distributed pro rata among all shareholders.