Liquidation Preference

An investor's right to get their money back before other shareholders in an exit event.

Definition

Liquidation preference defines the order and amount investors receive in an exit (acquisition, IPO, or shutdown). A 1x non-participating liquidation preference means the investor gets their investment back OR their pro-rata share of proceeds, whichever is higher. Participating preferred means they get their investment back AND their pro-rata share. Multiple liquidation preferences (2x, 3x) mean the investor gets 2-3x their investment back before anyone else.

Most standard deals use 1x non-participating preferred, which is relatively founder-friendly. Participating preferred and multiples are investor-aggressive terms.

Why it matters for founders

Liquidation preferences determine how exit proceeds are distributed. In a modest exit, aggressive liquidation preferences can mean founders and employees receive nothing. Understanding these terms prevents signing deals that look good on paper but hurt in practice.

Example

A startup raises $5M at a $20M post-money valuation with 1x non-participating preferred. If the company sells for $15M, investors can take $5M (their preference) or 25% of $15M ($3.75M). They choose the $5M preference, leaving $10M for common shareholders. If participating, they'd take $5M + 25% of the remaining $10M = $7.5M total.

How Foundra helps

Foundra helps founders understand fundraising terms so they can negotiate from a position of knowledge when reviewing term sheets with liquidation preference clauses.

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