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It means that when an exit happens, investors can have different rights to how the money is distributed. Suppose you own a company and sell 50% of it to VC X f
by ulf 16y ago
It means that when an exit happens, investors can have different rights to how the money is distributed.
Suppose you own a company and sell 50% of it to VC X for 1 Million Dollars (2M$ valuation). The VC gets a liquidation preference, which means they will get paid before you in an exit. If you sell for more than 2 million, that is no problem. But if you sell for less, the following happens:
Suppose someone wants to buy you for 1.2M$, which you agree to because you feel like the business is a dead end. According to the shares, you and the VC should get 600K$ each. But since VC x has a liquidation preference, they get their money back. So you get just 200K$ as the found. Even worse if you sell for less than 1M$, in that case you walk away empty-handed...
- amackera 16y agoThis doesn't really seem fair...
- byrneseyeview 16y agoNot really. A liquidation preference is worth something, so if you really didn't want to give on, you could give up more equity. But as Fred Wilson once pointed out, it's a great way to handle a situation where the founder thinks the company is worth way more than the VC does. If the founder is right, the VC owns less stock than they otherwise would have; if the VC is right, and the company is bought for a low valuation, the VC gets a higher percentage of the payout. Essentially, a liquidation preference can give you "conditional equity"--the founders own, say, 50% of the company if it's sold for a small amount, and 80% if it's sold for a large amount.
- adw 16y agoI think you'd find a broad consensus among founders and VCs that 1x non-participating is pretty much entirely fair (and standard!) the whole time. Other pref structures often mean that either the VC had the upper hand in negotiations or that there's a big divide in valuation to cross.