{"id":30490,"date":"2024-11-13T11:57:05","date_gmt":"2024-11-13T16:57:05","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/?post_type=biws_kb&p=30490"},"modified":"2026-02-25T21:23:35","modified_gmt":"2026-02-26T02:23:35","slug":"liquidation-preference","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/venture-capital\/liquidation-preference\/","title":{"rendered":"The Liquidation Preference in Venture Capital: Full Tutorial and Excel Examples"},"content":{"rendered":"

Liquidation Preference Definition:<\/strong> In venture capital and startup investing, a liquidation preference<\/strong> gives VC investors the option to earn back a fixed multiple of their investment in a company sale or shutdown rather than a percentage of its common equity, which provides downside protection in disappointing outcomes.<\/p><\/blockquote>\n

VC investors get this Liquidation Preference because they normally invest in startups via Preferred Stock<\/strong>, not Common Stock, and the Preferred Stock carries additional rights and privileges that make it senior to Common Stock.<\/p>\n

One of these rights and privileges is the Liquidation Preference, which is easiest to illustrate with a simple numerical example.<\/p>\n

Let\u2019s say that a VC-backed startup has two outside investors: The Seed investors, which invested $2 million, and Series A investors, which invested $5 million.<\/p>\n

After these funding rounds and several stock and option grants to employees, the Seed investors own 15% of the company, and the Series A investors own 25% according to the cap table<\/a>.<\/p>\n

If this startup now sells for $100 million, the Seed investors earn 15% * $100 million = $15 million, and the Series A investors earn $25 million.<\/p>\n

The Seed investors earn a 7.5x multiple, the Series A investors earn a 5.0x multiple, and everyone is happy:<\/p>\n

\"$100<\/p>\n

But now imagine that the startup sells for a much lower value, such as $10 million.<\/p>\n

Without<\/em> Liquidation Preferences, the Seed investors earn $1.5 million, and the Series A investors earn $2.5 million, so they both lose money in the deal:<\/strong><\/p>\n

\"Money<\/p>\n

They lose money because they invested at<\/strong> valuations higher than $10 million<\/strong>, so they \u201cbought high and sold low.\u201d<\/p>\n

If both investor groups had 1x Liquidation Preferences, the Series A investors would earn $5 million, and the Seed investors would earn $2 million:<\/p>\n

\"Liquidation<\/p>\n

When there\u2019s a Liquidation Preference, the investor group has the option<\/strong> to earn either a fixed multiple of their initial investment or<\/em> their Ownership % * Exit Equity Value.<\/p>\n

With the first option, the investor group stays in Preferred Stock<\/strong>; with the second, they convert to Common Stock<\/strong>.<\/p>\n

In this case, the investors would prefer to earn $5 million and $2 million rather than $2.5 million and $1.5 million, so they stay in Preferred Stock<\/strong> and take their Liquidation Preferences.<\/p>\n

The concept<\/strong> of a Liquidation Preference is not complicated, but if you want to implement it in Excel robustly, some of the formulas can be tricky.<\/p>\n

Files & Resources:<\/strong><\/h3>\n

Liquidation Preference Guide \u2013 Slides (PDF)<\/a><\/p>\n

Simple Liquidation Preference Example (XL)<\/a><\/p>\n

Video Table of Contents:<\/strong><\/h3>\n