liquidation preference

Liquidation preference is a key term in venture capital and startup financing. A liquidation preference clause defines how proceeds are distributed in the event of a liquidation; such as an acquisition, merger, or bankruptcy.

This clause ensures that early-stage investors recover their initial investment (and sometimes a multiple of it) before common shareholders receive any payout. It acts as a form of insurance, protecting venture capitalists and angel investors from downside risk.

There are different types of liquidation preferences, including:

• 1x Non-Participating: Investors get back exactly what they invested.
• Participating: Investors get their money back first, and then share in the remaining proceeds with common shareholders.
• Capped Participating: Same as above, but with a limit on how much they can receive in total.

Understanding liquidation preferences is crucial for both founders and investors when negotiating a term sheet or securing funding.

Read the full article on liquidation preferences to explore real-world examples.