# Liquidation Preference

## Quick Definition  
The right of preferred shareholders to receive their investment back before common shareholders in a sale or liquidation.

## What is Liquidation Preference?
Liquidation preference determines how proceeds are distributed when a company is sold or liquidated. Preferred shareholders (investors) typically get their investment back before common shareholders (founders, employees) receive anything.  
A 1x non-participating preference means investors get their money back first, then decide whether to convert to common for their pro-rata share of remaining proceeds.

## Types of Liquidation Preference
- **Non-participating**: Investors choose between preference OR converting to common (most founder-friendly).  
- **Participating**: Investors get preference AND their pro-rata share of remaining proceeds (investor-friendly).  
- **Capped participating**: Participating up to a maximum return multiple.

## Why Liquidation Preference Matters
In small exits, liquidation preference can mean common shareholders receive nothing. In large exits, the preference becomes less important as converting yields more. Understanding your preference stack is critical for evaluating exit scenarios.

## Formula
Liquidation Proceeds = Investment Amount × Liquidation Multiple  
1x = Get investment back first  
2x = Get 2× investment back first  
Participating = Get preference AND pro-rata share of remainder

## Example
Exit scenario with 1x non-participating preference:  
- Series A invested: $5M for 25%  
- Company sells for: $15M  
Option A (take preference): $5M  
Option B (convert to common): 25% × $15M = $3.75M  
Investor takes the $5M preference. Remaining $10M goes to other shareholders.  
If sale was $30M: Convert for $7.5M beats the $5M preference.

## Related Terms
- **Preferred Stock**  
A class of stock with special rights including liquidation preference and anti-dilution protection, typically held by investors.  
[Learn more](/content/terms/preferred-stock/index.html)  
- **Participating Preferred**  
Preferred stock that receives its liquidation preference plus participates pro-rata in remaining proceeds with common shareholders.  
[Learn more](/content/terms/participating-preferred/index.html)  
- **Anti-Dilution**  
Protection that adjusts an investor's share price if the company later raises money at a lower valuation.  
[Learn more](/content/terms/anti-dilution/index.html)

## Learn More About Liquidation Preference  
[Fundraising **How Venture Capitalists Actually Work: A Founder's Guide to the VC Process**  
A founder's guide to how venture capital actually works, from fund structure and the investment process to due diligence and pitching VCs effectively.  
Read article](/content/blog/venture-capital-fundraising-process-founders-guide/index.html)

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