Login to Reportally


Following on from our Cap Table Univeristy post on Liquidation Preferences and Liquidation Multiples, when a VC investor requests a Liquidation Preference they may also ask for their investment to be Participating

Participating means that once the VC has received their return from the Liquidation Preference, they will immediately share in any further upside alongside the other Investors and Founders.

Non-participating means that once the VC has received their return from the Liquidation Preference, they will wait until the other Investors and Founders have achieved the same return per share, before getting any further upside.

Let's see this in action...

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.

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 VC has a Participating investment

  • The company is sold for $11M
  • The VC gets the first $5M (as this is their Liquidation Preference of: $2.5M x 2.0x = $5M) and
  • The Founders and other Investors split the remaining $6M with the VC. So the VC gets an additional $2M (33% of $6M), the other Investors and Founders get $4M
  • In total, the VC gets $7M back

Example 2: the VC has a non-participating investment

  • The company is sold for $11M
  • The VC gets the first $5M (as this is their Liquidation Preference of: $2.5M x 2.0x = $5M), then...
  • The VC waits until the other Investors and Founders get the same share price before the VC gets any more. This would happen when the total valuation is $15M or higher (take the VC return, divide by their ownership 33%); but...
  • The valuation is less than $15M, so the Founders and other Investors get the remaining $6M
  • In total, the VC gets $5M back

So, the Participating clause can cost the Founders and early Investors $2M in this example!

Example 3: the VC has a non-participating investment; and the business is sold for $21M

  • The company is sold for $21M
  • The VC gets the first $5M (as this is their Liquidation Preference of: $2.5M x 2.0x = $5M), then...
  • As before, the VC waits until the other Investors and Founders get the same share price before the VC gets any more - at a valuation is $15M or higher
  • The Founders and other Investors get the difference to a valuation of $15M (being $10M)
  • At this point, the share price is the same for the VC and the other Investors, so they now all share in the remaining $6M ($21M less $15M). The VC gets $2M of the additional $6M (as they have 33%)
  • In total, the VC gets $7M back, and the Founders and other Investors get $14M

Comparing example (1) to example (3) shows that the VC gets the same outcome if (1) the business is sold for $11M and have Participating; and (2) the business is sold for $21M and the have non-participating!

Modelling using Reportally: 

It's very easy to model Participating, and see its 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. There is an option underneath to select "Participating" - decide whether you want this on or off
  4. Click "Save" and you're done!

The Liquidation Chart will clearly show the impact of the Participating clause

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

Level: 
Intermediate




Free Investor Reporting Platform • Cap Table Management • Investor Dashboard
Reportally is a free-to-use platform with everything you need to manage your startup funding: Cap Table management, Investor Reporting and more...

Question or Feedback?