What is Liquidation Preference?

A liquidation preference determines who gets paid first and how much when a company is sold or liquidated. Preferred shareholders (investors) typically get their money back before common shareholders (founders, employees).Types:1x non-participating: Investors get back 1x their investment OR their equity share (whichever is more)1x participating: Investors get 1x back AND their share of remaining proceeds ('double-dip')2x, 3x: Multiples of investment returned firstExample: $100M exit, investor owns 20%, invested $30M with 1x non-participating preference. They choose max of $30M (1x) or $20M (20%). They take $30M. With participating preferred, they'd get $30M + 20% of $70M = $44M.Impact: High liquidation preferences can leave founders with nothing in modest exits.How preferences shape exit returns: In any acquisition or liquidation event, investors with liquidation preferences are paid before common shareholders see a single dollar. The most common structure is a 1x preference, meaning investors recoup their original investment first. However, in competitive fundraising environments, investors may negotiate 2x or even 3x multiples, requiring the company to return two or three times the invested capital before other shareholders participate. The distinction between participating and non-participating preferences is critical. Non-participating preferred holders choose between their preference amount or their pro-rata share of proceeds, whichever is greater. Participating preferred holders receive their preference amount and their pro-rata share of the remaining proceeds, effectively double-dipping. This participating structure can dramatically reduce payouts to founders and employees, especially in moderate exits where the total proceeds barely exceed the preference stack.