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Liquidation preferences are a hugely important term that protects investors from being screwed over by founders. Without it, nothing stops an unethical founder
by SeoxyS 11y ago
Liquidation preferences are a hugely important term that protects investors from being screwed over by founders. Without it, nothing stops an unethical founder from raising 800k at a 8M cap, and turning right around and letting the company get acqui-hired for 4M a month later, pocketing $3.6M and leaving the investors with half their money.
With a liquidation preference; investors get their money back, the founders take their $3.2M, and nobody walks away feeling screwed over.
[Note: this example works exactly the same if you multiply the numbers by 100.]
As an investor; I don't invest unless I have 1x liquidation preference and pro-rata rights. These terms are standard because they're fair and they're critical for protecting the investor.
- vasilipupkin 11y agothat's why the article is so ridiculous. VC doesn't make sense without liquidation preference, so founders would be MORE screwed without it because they would not have any funding for their startups !
- chralieboy 11y ago> nothing stops an unethical founder from raising 800k at a 8M cap, and turning right around and letting the company get acqui-hired for 4M a month later, pocketing $3.6M and leaving the investors with half their money. Except that they just exchanged a stake worth $7.2m and sold it for $3.2m. Founders with large stock options are _more_ incentivized than even investors to maximize valuation in the event of a sale. I understand that you want to make a bet while minimizing risk, but if you're going to try and guarantee your money back then as a company I'm going to price that in by minimizing the upside. Without liquidation preferences, you as an investor can negotiate more reasonable valuations (if you're setting a cap of $8m and the company is willing to take a $4m buyout, you've seriously mispriced the company.) That means more potential upside.
- otterley 11y ago> Without [liquidation preferences], nothing stops an unethical founder from raising 800k at a 8M cap, and turning right around and letting the company get acqui-hired for 4M a month later, pocketing $3.6M and leaving the investors with half their money. Of course there is something to stop this: membership on the board of directors. Large investors should -- and usually do -- demand board seats so that they have representation in major decisions such as this.