What is the amount of a typical liquidation preference?
June 12, 2007
The amount of the liquidation preference is a function of the risk of the investment. In typical venture financings, the amount of the liquidation preference is the amount invested by the investors. In other words, if the Series A was issued for $1.00/share, a holder of one share of Series A receives $1.00 prior to any distributions to holders of common stock. This is referred to as a 1x preference. During the 2001 to 2003 time period, liquidation preferences of multiples greater than the purchase price (expressed as 2x, 3x, etc.) were not unusual. Liquidation preferences of greater than 1x may be negotiated when a company has had difficultly raising funds.
Aggressive liquidation preferences can wipe out the interests of holders of common stock absent a “home run.” If a company raises a lot of money with liquidation preferences greater than 1x, then the amount that the company must be sold for in order for the holders of common stock to receive a return may be quite high. This is sometimes not fully understood by founders and management.