Liquidation Preference
An investor's right to receive their money back (or a multiple of it) before founders and employees in a sale or liquidation.
Definition
A liquidation preference is a term in an investment agreement that gives investors the right to receive a specified amount — typically 1× their investment — before other shareholders receive anything in a sale, merger, or liquidation. Participating preferred shares go further: after receiving their preference, investors also participate pro-rata in the remaining proceeds. Non-participating preferred shares must choose between the preference or converting to common shares.
Why It Matters
Liquidation preferences can dramatically reduce founder and employee payouts in moderate exits. A $20M exit with $15M of 2× participating preferred investment could leave common shareholders with almost nothing. Understanding preference stacks is critical when negotiating term sheets.
Example
Investor puts in $5M at 1× non-participating preferred. At a $30M sale, they receive $5M (their preference) and convert to common only if their pro-rata share exceeds that amount.