Liquidation Preference
Definition
A right held by preferred stockholders (investors) to get paid back before common stockholders (employees, founders) in a liquidation event (acquisition, wind-down). A 1x non-participating liquidation preference means investors get their money back first. A 2x preference means they get double their investment back first. Participating preferences let investors get their preference AND share in the remaining proceeds.
Real-World Example
Investors put in $50M with 1x non-participating preference. The company sells for $80M. Investors take $50M off the top. The remaining $30M is split among common stockholders. If the company sold for $40M, investors take all $40M and common stockholders get nothing.
Common Mistake
Ignoring liquidation preferences when valuing your equity. If the company has raised $100M with 1x preferences, the first $100M of any exit goes to investors. Your common stock only has value above that threshold. Many employees are shocked to receive nothing from a "successful" acquisition.
Why It Matters
Liquidation preference is the single most important concept for understanding what your equity is actually worth in an exit. A company can be "acquired for $200M" but if there is $150M in liquidation preferences, employees split the remaining $50M.
Related Terms
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