What is liquidation preference?
Short Answer
Liquidation preference specifies how proceeds from an exit are distributed between preferred shareholders (investors) and common shareholders (founders, employees), determining who gets paid first.
Full Explanation
In a typical Series A term sheet, investors receive preferred stock with liquidation preference rights. These determine the waterfall of payments if the company is sold. A 1x non-participating preference means investors get their money back first (1x their investment), then remaining proceeds go to common shareholders. A 2x participating preference means investors get 2x their investment first, then participate pro-rata in remaining proceeds alongside common shareholders. Participation is founder-unfriendly: if a company exits for £10M and investors invested £2M, a 1x non-participating means investors get £2M and founders get £8M. But a 2x participating means investors get £4M first, then participate in the remaining £6M pro-rata (if they own 30%, they get another £1.8M, reducing founder proceeds to £4.2M). Non-participating preference is more founder-friendly. Most Series A rounds include non-participating, but Series B+ increasingly includes participating preference. For founders, understanding liquidation preference is critical — it can dramatically reduce exit proceeds, especially if the company exits for only 2-3x invested capital.
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