What Is a Liquidation Preference?
Priority liquidation is a common investor priority in investment.
- Chinese name
- Priority liquidation
- Foreign name
- liquidation preference
- Nature
- Investor priority
- Related documents
- Term sheet
- Priority liquidation is a common investor priority in investment.
- Priority liquidation refers to PE (
- 1,
- Generally speaking, the liquidation priority has two components: preference (Preference) and participation (Participation).
- There are three types of participation distribution rights, or Double Dip: Non participation, Full participation, and Capped participation. There are three types of liquidation preferences. right:
- 1. Non-participating liquidation preference
- Reference Example: Liquidation Preference: In the event of any liquidation or winding up of the Company, the holders of the Series A Preferred shall be entitled to receive in preference to the holders of the Common Stock a per share amount equal to [x] the Original Purchase Price plus any declared but unpaid dlidends (the Liquidation Preference).
- Liquidation Priority: at
- Many VC adoptions have participation rights
- Talk about liquidation
- Liquidation when negotiating Term Sheet for Series A financing
- Most professional and rational investors are unwilling to squeeze excessive liquidation priorities from companies. Because the higher the liquidation priority return, the lower the potential value of management and employee equity. Each case is different, but there is an optimal balance point. A rational investor wants to obtain the "best price" while ensuring the "maximum incentive" for management and employees. Obviously, the final result needs to be negotiated and depends on the company's development stage, bargaining power, current capital structure, etc. [2]
- Suppose ABC Company's pre-investment valuation is $ 10M and the investment amount is $ 5M. The clearing priority multiples that the investor requires to participate in the distribution are 2 times (2X), and the upper limit of the liquidation return is 4 times (4X).
- According to the above data, the investor's share (convertible preferred stock) ratio is 33% ($ 5M / ($ 10M + $ 5M)), the preferred liquidation amount is $ 10M ($ 5M x 2), and the liquidation return cap is $ 20M ($ 5M x 4)
- 1. If the value of the company at the time of liquidation is lower than the investor's priority liquidation amount, which is $ 10M, then the investor takes all of it.
- 2. If the value of the company at the time of liquidation is higher than $ 60M, the investor will convert the preference shares into ordinary shares, and the liquidation value will be distributed according to the share ratio (33%) with the shareholders of the ordinary shares. The investor will receive a return greater than $ 20M ( $ 60Mx33%), and is not subject to the cap on liquidation returns of preferred shares ($ 20M).
- 3. If the company's liquidation value is between $ 10M and $ 60M, the investor first obtains the preferential liquidation amount ($ 10M), and then distributes the remaining liquidation value with the ordinary shareholders according to the share ratio. At this time, there is an interesting situation: when the liquidation value is between $ 40M to $ 60M, after the investor takes the priority liquidation amount, the remaining liquidation value is $ 30-50M, and the investor can theoretically allocate according to the share ratio The amount is $ 10-16.7M, and the return of the two investors is $ 20-26.7M (= preferential settlement amount of $ 10M + remaining liquidation value * 33%), which has exceeded the upper limit of liquidation return of $ 20M. Therefore, according to the agreement At this time, investors still only get $ 20M, and the excess is distributed by common shareholders. [3]
- The specific returns are shown in the following figure: