Liquidation Preference

A contractual right for preferred shareholders to receive a stated multiple of their investment back before common shareholders receive anything, in a sale or wind-down.

Example

A 1x non-participating preference on a 2,000,000 investment guarantees that investor at least 2,000,000 of any exit proceeds, ahead of common, or their as-converted share if that is larger.

Important

The preference is what a preferred share's price is actually buying beyond ownership - two shares priced identically are not equivalent instruments if only one carries a preference.

Related terms

• Post-Money Valuation — A company's agreed value immediately after a financing round's new money has been added, equal to the total resulting share count multiplied by the round's price per share.
• Preferred stock — A class of shares ranking ahead of common stock for dividends and in a wind-up, usually paying a fixed or formula-based dividend and usually carrying no vote.
• Anti-Dilution Provision — A contractual term that adjusts an earlier investor's conversion price downward if a later round prices shares lower, protecting them from a down round's effect on their ownership.

Lessons that explain it

• With several preferred classes, each one decides whether to convert — When a company has several classes of preferred shares, exit proceeds are divided in order of seniority, and each class chooses between its preference and converting. Working through exits of different sizes shows how common shareholders are affected. (12 min)
• The headline sale price is not what investors receive — Proceeds from a sale flow through debt, transaction costs, preferences, escrow and earnouts before reaching each shareholder. The waterfall decides what a headline price is worth to you. (13 min)
• Selling early means accepting a discount; a wind-down usually means preferences take what is left — A secondary sale can return cash before a company exits, typically below the latest valuation. When a company winds down, creditors and preferences are paid first, and common holders commonly receive nothing. (11 min)
• A director appointed by an investor owes duties to the company, not to that investor — Board directors generally owe fiduciary duties to the company and its shareholders as a whole. An investor-appointed director who puts their fund's interests first can breach those duties, which is the central tension in startup governance. (12 min)
• Two shareholders can own the same percentage and receive very different amounts — Common and preferred shares can represent the same ownership percentage, but preferred shares usually come with rights - especially liquidation preferences - that decide who gets paid first when a company is sold. (10 min)
• Every instrument answers one question differently: what happens if it goes badly — Warrants give the right to buy shares at a set price. Venture debt is a loan that ranks ahead of equity and often comes with warrants. In a poor outcome, the order of claims decides who recovers anything. (11 min)

All 578 terms in the Investing glossary