Liquidation Preference
Investor Protection in Exit Scenarios
Definition
Liquidation preference is the right for preferred shareholders to be paid a specific amount (usually their investment) before common shareholders in an exit or liquidation event.
In Simple Terms
If the company is sold or goes bankrupt, investors with liquidation preference get "first dibs" on the sale proceeds. They get their money back (or a multiple of it) before founders and employees see any proceeds.
Why It Matters
Liquidation preference is crucial in term sheet negotiations. A 1x preference means investors get their money back first; 2x means they get double. Non-participating preference is better for founders. Understanding this clause determines your payout in exit scenarios.
Example
Company sells for $50M. Investors put in $20M with 1x liquidation preference. They get $20M first. Remaining $30M is split among all shareholders based on ownership. If the company sold for $15M, investors get $15M and founders get $0.