Fundraising Jargon 05: Liquidation Preferences

The primary objective of any VC or other investor is to make money out of their investment. Their investments are no good unless they eventually realize a payday. In venture parlance, these paydays are referred to as “liquidity events,” the moments when everyone with an equity stake gets a chance to cash out. These events come in the form of acquisitions or an IPO.

Liquidation preferences determine who gets paid what and when during these events. If the company goes bankrupt (may come up as a liquidation event for less successful companies), for instance, there are often not enough assets left to pay every creditor and shareholder the money due to them. In such a case, liquidation preferences determine the order in which everybody gets paid. In general, creditors get paid first, then preferred stockholders, then, if there is anything left, common stockholders.

Liquidation preferences are also relevant during more successful outcomes though. The standard and most beneficial liquidation preference from an entrepreneur's perspective is 1X, meaning that preferred stock owners must get their money back (1 x their money) before common stockholders get anything.