When you’re raising money for your startup, there are a lot of terms and concepts that you need to familiarize yourself with. One of the most important of these is “liquidation preference.” Put simply, this refers to the order in which investors get paid in the event of a liquidation event.
There are several different types of liquidation preference that you might encounter as a startup founder. Here are the most common:
1. Non-participating preferred: This means that investors get paid back their initial investment amount before any other distributions are made. However, they don’t get to participate in any further payouts beyond that.
2. Participating preferred: With this type of liquidation preference, investors get their initial investment amount back, plus a percentage of any remaining proceeds that are distributed.
3. Multiple liquidation preference: This means that investors get back a multiple of their investment before other distributions are made. For example, if an investor has a 2x liquidation preference, they’ll get paid back twice their initial investment amount before anyone else gets a payout.
4. Capped liquidation preference: This is a combination of a multiple and a participation preference. Investors get their initial investment amount back, plus a percentage of any remaining proceeds, up to a certain cap. Once that cap is reached, they revert to a non-participating preferred status.
As a startup founder, it’s important to understand the implications of these different types of liquidation preference. A non-participating preferred structure can be beneficial for founders, as it means that investors won’t be able to take a larger share of any future profits. However, it can also make it harder to attract investors in the first place.
On the other hand, a participating preferred structure can be more attractive to investors, but it means that founders will have to give up a larger share of future profits. Multiple and capped liquidation preferences can be even more complex, so it’s important to have a good understanding of the math before agreeing to any terms.
In general, it’s a good idea to negotiate liquidation preferences with your investors before accepting any funding. Make sure you understand the trade-offs involved with each type of preference and don’t be afraid to push back if you feel that the terms are unfair.
By understanding liquidation preference and negotiating smartly, you can ensure that your startup is set up for long-term success.
