Liquidation Preference Calculator – Participating Preferred vs Non-Participating Preferred – free tool

Liquidation Preference Participating Preferred vs Non-Participating Preferred

Liquidation Preference: Participating vs Non-Participating (free tool)

  Adam Tzagournis, CPA ยท 2 min read

We recently released a free tool to help startup founders understand liquidation preference, participating preferred stock, and non-participating preferred stock. These are terms you must know if you take on outside capital – they dictate how much money you make if you sell your company.

What is liquidation preference?

Liquidation preference sets a minimum amount of money to be returned to an investor in the case of an acquisition. It protects their downside risk when investing in your startup, and is typically equal to the amount they invested in you (see more below).

What is non-participating preferred stock?

Non-participating preferred stock means that, if the startup gets acquired the investor gets to choose between the greater of either:

  • their initial investment back, or
  • their % ownership of the company at exit

What is participating preferred stock?

Participating preferred stock takes investor protections a step further (too far in my opinion). It’s when the investor, at exit, gets both their initial investment and their % ownership of the remaining proceeds. They’re double-dipping.

Liquidation preference in fundraising

Let’s say you take investment from LMKHICBH Capital, my favorite fictional VC firm.ย They invest $20mm at a $20mm pre-money valuation (they’re sharks), so after the round they own 50% of the company.

If things go south and you sell your company for $20mm, they get their entire $20mm back and you get $0. You’re flying coach on that next vacation.

Participating vs non-participating

Don’t worry – we’re not done yet. Instead, let’s say you sell your company for a cool $50mm.ย Nice! Now you’re excited for that tropical vacation. ๐Ÿ–

Let’s take a closer look though.

Scenario A - easy

LMKHICBH’s preferred stock is non-participating preferredย ๐Ÿ˜ƒ

  • LMKHICBH gets $25mm
  • You get $25mm

Scenario B - wait a second

LMKHICBH’s preferred stock is participating preferred ๐Ÿ˜ต

  • LMKHICBH gets their initial $20mm back, and ๐˜ข๐˜ญ๐˜ด๐˜ฐ gets 50% of the remaining $30mm proceeds, for a total of $35mm
  • You get the $15mm left over

Scenario C - buckle up

LMKHICBH’s preferred stock is participating preferred with 2x liquidation preference ๐Ÿคฏ

  • LMKHICBH gets 2x their initial $20mm ($40mm), and then ๐˜ข๐˜ญ๐˜ด๐˜ฐ gets 50% of the remaining $10mm in proceeds, for a total of $45mm
  • You get just $5mm

Wrapping up

Ok, you’re still flying first-class in all these. But the outcomes vary wildly. Investor dollars are not all equal. Make sure you know what you’re signing up for, and what the liquidation preference stack looks like.

Oh yea, almost forgot:

LMKHICBH = let me know how I can helpful ๐Ÿ™ƒ

A better way

Not sure how to calculate liquidation preference for your startup? Use our free tool we built just for this purpose!