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When a VC investor invests as part of a Series A or Series B round; they will often seek a Liquidation Preference with a Liquidation Multiple. This means they will get paid back first out of any proceeds in the event of a sale of the company.

Liquidation Multiples
The VC may get paid back many times their original investment (a Liquidation Multiple), before any other investor receives a Return. Usually the Liquidation Multiple is 1.0x. This means they will get their money back before any other investor gets a penny.

Why do VCs ask for this?
The Founders and early stage investors will know much more about the company before the VC invests; and will often stand to gain most if the company is really successful. And a VC's overall return across their fund can be heavily impacted by write-offs (investments that return nothing). The Liquidation Preference clause protects the VC on the downside, and motivates the Founders to shoot for a large outcome.

Did you know?: a Liquidation Preference will have no impact on the appearance of the Fully Diluted cap table, but can have a big impact on the overall returns to different investors. Particularly at low outcomes. That's why it's important to model the outcomes on a good cap table builder

Worked Example: 

Let's say:

  • A VC invests $2.5m on a pre-money valuation of $5m, with a liquidation preference of 2.0x
  • They get 33% of the company

Example 1:

  • The company is sold for $4M
  • The VC gets $4M (as this is less than their Liquidation Preference of: $2.5M x 2.0x = $5M)
  • The Founders and other Investors receive nothing

Example 2:

  • The company is sold for $12M
  • The VC gets the first $5M (as this is their Liquidation Preference of: $2.5M x 2.0x = $5M) plus the remainder is split between the VC and the other Investors and Founders
  • To see exactly how much they get, you may like to see our related guide on "Participating"

Modelling using Reportally: 

It's easy to model Liquidation Preferences, and see their impact using Reportally's cap table builder:

  1. Add a new equity round
  2. In the round option you'll see "Liquidation Preference": type in a liquidation multiple here, e.g. 1.0
  3. Click "Save" and you're done!

The Liquidation Chart will clearly show the impact of the Liquidation preference (the VC getting a return before all other investors); and the impact will also go into the Returns calculations.

Why not try it now - create a cap table and test the difference scenarios

Level: 
Intermediate




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