![]() ![]() Preferred stock has downside protection in case of a distressed sale of the company but the upside of owning the preferred stock is limited. #LIQUIDATION PREFERENCE FULL#It covers the dollars invested on a one-to-one basis and even through the investor’s ownership would entitle them to only $7.5 million, they receive the full $10 million they invested. Later, it’s sold for $25 million and the venture investors collect $10 million in the form of a liquidation preference known as 1X. Let’s look at a simple example: a company raises $10 million in venture capital funding in exchange for a 30% stake in the company. Typically, a liquidation preference is for one times (1X) or higher return on capital. The ‘liquidation preference’ refers to the dollar amount that the stockholder of a preferred stock receives prior to holders of common stock in the event the company is sold or otherwise liquidated and its assets are distributed to stockholders. Liquidation Preference Usually Means Preferred Stock Of course, there are many other rules on preferred stock including participation, capped participation, and others but we’ll focus on these two primary types of stock for our purposes. ![]() Venture capital investors almost always insist upon having preferred stock because the holders of such stock receive preferential treatment in the case of a liquidation event. Typically owned by venture capitalists and other investors in the company. Preferred Stock – has some ‘preferences’ over common stock like dividend and redemption rights, conversion and voting rights, etc. Typically the type of stock held by founders and employees. The following are the two most common types of stock and who holds each type:Ĭommon Stock – the basic equity interest in a company. So, what is a ‘liquidation preference’ and what does it mean to business owners and investors? Term Sheet Facts – Types of Stock #LIQUIDATION PREFERENCE SERIES#(See How do you Understand a Series A Term Sheet for term sheet details.) The term ‘liquidation preference’ is one of the essential components of a preferred stock agreement – it’s generally considered the second most important term in a venture capital investment and it’s outlined on the term sheet. ![]()
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