Liquidation Preferences: What They Are and How They Work

Liquidation preferences determine who gets paid (and how much) if your company exits. Typically granted to preferred shareholders, they affect founder payouts and influence deal outcomes in downside scenarios.

Why it Matters

Liquidation preferences determine who gets paid first — and how much — when your startup exits.

They can mean the difference between a founder payday… or walking away with nothing.

Founders Checklist

Understand how liquidation preference works in priced rounds
Confirm whether it's 1x non-participating (standard) or more aggressive
Avoid stacking preferences across multiple rounds
Model outcomes in low-exit scenarios — especially in down rounds
Negotiate for capped or non-participating terms if possible

Founder Fails

Agreed to participating preferred > investors got 2x, founders got 0
Didn’t model exit waterfall > assumed $50M exit meant $10M payday (it didn’t)
Didn’t realize stacked preferences from multiple rounds wiped out common shareholders

When to ask for Help

When negotiating your first priced round
To understand 1x vs. multiple liquidation preferences
If you’re being asked for participating preferences
Before signing term sheets with preference stacking
When modeling founder outcomes in exit scenarios

Frequently Asked Questions

Q: What is a liquidation preference?
A: It gives investors the right to get their initial investment back first — before common shareholders (i.e., founders/employees) see a dime — when the company is sold or liquidated.

Q: What’s “1x non-participating” mean?
A: It means investors get back exactly what they put in — and then stop. After that, remaining proceeds go to common shareholders.

Q: What’s a “participating preferred” share?
A: It’s an investor-friendly term where they get their money back first, then also share in the upside as if they had converted to common — double-dipping.

Q: What happens in a low exit?
A: If the exit price is close to or below the total preferred investment, founders may get nothing unless preferences are capped or waived.