Liquidation preference determines the order and amount in which investors are paid before common shareholders when a company is sold, merged, or liquidated. The standard is 1x non-participating preferred: investors get back either 1x their investment or their pro-rata share of proceeds (whichever is higher), but not both. Participating preferred allows investors to get their money back AND share in remaining proceeds, which is less founder-friendly.
1x non-participating: Investor gets 1x their money back OR converts to common (whichever is higher).
Participating: Investor gets 1x back AND shares in remaining proceeds. Less founder-friendly.
Affects how exit proceeds are distributed. Higher preferences can significantly reduce founder returns in modest exits.
$2M invested at 20% ownership with 1x non-participating. $8M exit: investor takes $2M (1x) or $1.6M (20%). Chooses $2M.
Stacking preferences across rounds; not modeling downside scenarios; accepting participating preferred without understanding impact.
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