Liquidation preference

Definition

What investors take off the top of a sale before anyone else is paid.

Why It Matters

It decides who is made whole when the business sells, and it bites hardest in the outcomes nobody models. A one times preference returns the invested capital first and the rest is split; a multiple returns more than was put in before the searcher sees a cent. The word that matters most is participating: a participating preference takes the capital back AND then shares in what is left, so investors are paid twice out of the same sale, while a non-participating one makes them choose between the preference and their percentage. On a strong exit the choice is academic. On a middling one it is the difference between a life-changing number and nothing, so read which kind you signed before you model anything.

In numbers: On a $2,000,000 raise with a 1x participating preference and 30% of the common, a $3,000,000 sale returns the $2,000,000 first, then hands investors 30% of the remaining $1,000,000. The searcher keeps $700,000. Make that preference non participating and investors take the larger of $2,000,000 or 30% of $3,000,000, so the searcher keeps $1,000,000.