What is Liquidation Preference?
Nexa Consultancy | Startup & Finance Glossary
A liquidation preference is a clause in a financing agreement that determines the payout order in the event of a company sale or liquidation. It gives preferred stockholders (investors) the right to receive their investment back before common stockholders (founders and employees) get anything.
Why it Matters for Startups:
This is one of the most critical terms in a venture deal. An aggressive liquidation preference (e.g., "participating preferred" or a multiple greater than 1x) can mean that founders and employees receive little to nothing in a modest exit scenario, even if the company is sold for more than its last valuation.
Example:
An investor puts in ₹5 Crore for 20% of a company with a "1x non-participating" liquidation preference. If the company is sold for ₹10 Crore, the investor gets their ₹5 Crore back first, and the remaining ₹5 Crore is distributed among the common shareholders. If it's sold for ₹50 Crore, the investor can choose to either take their ₹5 Crore back or convert their shares to 20% of the company and receive ₹10 Crore (whichever is greater).