Liquidation Preferences are one of the most important paragraphs of Term Sheets and contracts you’ll get from Venture Capital investors for your fundraising round. A Liquidation Preference could have a huge impact on the exit proceeds of a founder. Thus it’s crucial for every founder to understand how a Liquidation Preference functions and how it can impact their exit proceeds.
Huge fundraising rounds are often publicly celebrated. But many forget that the more a founder raises, the bigger the exit must be at the end to bring money back to the founders. In the following and in the linked Whitepaper, I’ll provide some simple examples that explain the mechanics of a so-called “Participating Liquidation Preference” and a “Non-Participating Liquidation Preference”:
1) 1 × Non-Participating Liquidation Preference
In case of an exit, investors with preferred shares receive the higher amount: Their investment OR their pro-rata share.
2) 1 × Participating Liquidation Preference
In case of an exit, investors with preferred shares always receive their investment plus their pro-rata share of the remaining proceeds.
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