Liquidation Preference

A liquidation preference is a contractual right giving preferred shareholders, typically venture investors, priority over common shareholders in receiving proceeds when a company is sold, liquidated, or otherwise exits, up to a specified multiple of their original investment before any remaining proceeds are split among other shareholders. A standard 1x non-participating liquidation preference means an investor gets back at least their original investment, or their pro rata share of proceeds if that is larger, whichever is greater.

How do liquidation preference multiples affect founders?

A 1x preference is considered founder-friendly and standard in healthy markets, while 2x or 3x preferences, more common in down markets or distressed financings, mean investors must be paid back two or three times their investment before common shareholders, including founders and employees holding options, see any proceeds at all. Participating preferred stock compounds this further, letting investors take their preference amount and then still participate in splitting the remaining proceeds alongside common shareholders.