In defence of liquidation preferences

The Equity Kicker

It turns out that ‘time bomb’ is the much maligned and, I suspect, little understood, liquidation preference. To be clear, liquidation preferences are sometimes used badly and founders should generally turn away from investors who ask for multiple liquidation preferences. However, most of the later rounds or companies raise feature simple 1x liquidation preferences and we’re fine with that.

Avoid Offensive Liquidation Preferences

The Startup Lawyer

In most equity financing rounds, an investor will ask for (and get) a term called a liquidation preference. A liquidation preference is the amount that must be paid to a preferred stock holder before any sale proceeds may be paid to the holders of common stock (i.e., The amount of the liquidation preference is usually expressed as a multiple, with the most common liquidation preference being “1X non-participating.”

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Price Cap Liquidation Preference Windfall Regulators

The Startup Lawyer

Depending on the delta between the price cap and the pre-money valuation of the qualified equity financing, the convertible note investors could receive a windfall in terms of liquidation preference. Most convertible notes have a price cap as a feature term. The Potential Problem Let’s say Series A investors invest at a pre-money valuation that [.]. Convertible Notes

More on Liquidation Preferences

Altgate

→ More on Liquidation Preferences Posted on December 16, 2010 by admin A long time ago I had asked a VC about what pre-money valuation he was planning to put in a term sheet he had promised to send over. But first, let’s look at pre-money valuation by liquidation preference.

No Mess (Too Much Liquidation Preference)

ithacaVC

Continuing with the “No Mess” theme of commenting on things that give VCs pause, I thought it would be good to touch on liquidation preference. Specifically, “too much” liquidation preference (I will use “LP” for liquidation preference). As most of you probably know, LP is one of the fundamental economic attributes of preferred stock that preferred shareholders enjoy.

@altgate » Blog Archive » The 3X Liquidation Preference Is Back!

Altgate

@altgate Startups, Venture Capital & Everything In Between Skip to content Home Furqan Nazeeri (fn@altgate.com) ← Holiday Cards Year End Management Changes → The 3X Liquidation Preference Is Back! Let’s recap how expensive a 3x liquidation preference really is.

VC Rights: Up, Down, And Know What The Fuck Is Going On

Feld Thoughts

Down: Liquidation preference. Term Sheet board seat liquidation preference pro-rata terms VCAt the HBS VC Alumni event I was at last week (no – I didn’t go to HBS – I was a panelist) I heard a great line from a wise old VC who has been a VC about as long as I’ve existed on this planet.

Top Ten Posts in 2011

Scott Edward Walker

What Is A Liquidation Preference? Miscellaneous antidilution crowdfunding legal checklist liquidation preference no shop startup startups term sheetsBelow is a list of my top ten posts in 2011 based solely on pageviews. Indeed, I was inspired by Chris Dixon and his post of last night (which you should definitely check-out). Moreover, I’m publishing an eBook with Hyperink entitled The Startup Law Playbook , which should be available shortly.

Everything You Ever Wanted to Know About Convertible Note Seed Financings (But Were Afraid To Ask) – Part 1

Scott Edward Walker

ii) why are convertible notes issued instead of shares of common or preferred stock? In the context of a seed financing, the debt typically automatically converts into shares of preferred stock upon the closing of a Series A round of financing. Most sophisticated investors, however, will not accept shares of common stock for their investment and will push hard for shares of preferred stock, with special rights (as discussed below).

Founder Liquidity

K9 Ventures

And that too usually when there is sufficient investor demand for the next round, i.e. the leverage needs to be in the company’s hand (rather than investors) for any type of founder liquidity to even be an option. There are several arguments against providing founder liquidity: 1) The money doesn’t go to the company, but into founders’ pockets : Yes, the money from founder liquidity does go to founders’ pockets, but that’s entirely the point.

Founder Liquidity

K9 Ventures

And that too usually when there is sufficient investor demand for the next round, i.e. the leverage needs to be in the company’s hand (rather than investors) for any type of founder liquidity to even be an option. There are several arguments against providing founder liquidity: 1) The money doesn’t go to the company, but into founders’ pockets : Yes, the money from founder liquidity does go to founders’ pockets, but that’s entirely the point.

Convertible Note Seed Financings: Econ 101 for Founders

Scott Edward Walker

ii) why are convertible notes issued instead of shares of common or preferred stock? As discussed in part 1 , in the context of a seed financing, a convertible note is a loan that typically automatically converts into shares of preferred stock upon the closing of a Series A round of financing. If the noteholders invested $500,000 and the price per share of the Series A Preferred Stock were $1.00, the noteholders would convert the loan at an effective price of $0.50

VC Term Sheets – Investors’ Option to Walk

Scott Edward Walker

Here are the issues I have addressed to date: common mistakes dealing with VC’s valuation liquidation preferences stock options exploding term sheets and no-shop provisions anti-dilution provisions dividends Board control protective provisions drag-along provisions pay-to-play and pull-up provisions conversion rights non-contractual rights redemption rights In today’s post, I examine the non-binding and conditional language in term sheets.

Doing Deals – 3 Tips for Entrepreneurs (Part 2)

Scott Edward Walker

Indeed, there comes a point in time in just about every deal where both sides have dug into certain positions and the question becomes which side will blink first; for example, in a venture capital financing, perhaps the issue is the liquidation preference or the size of the option pool ; or, in an acquisition, perhaps the issue is the cap on seller’s liability or the amount of the escrow.

Venture Capital Term Sheets: Conversion Rights

Scott Edward Walker

Here are the issues I have addressed to date: common mistakes dealing with VC’s valuation liquidation preferences stock options exploding term sheets and no-shop provisions anti-dilution provisions dividends Board control protective provisions drag-along provisions pay-to-play and pull-up provisions In today’s post, I examine conversion rights of investors. As many of you know, VC investors are typically issued shares of preferred stock, not common stock.

What Are the Rights of Minority Stockholders?

Scott Edward Walker

Indeed, whether a minority common stockholder is a founder, an advisor or even a friends/family investor, such stockholder will usually not be contractually granted any of the rights that are typically granted to preferred stockholders. Startup Issues anti-dilution provisions controlling stockholders conversion rights derivative claim fiduciary duty inspection rights liquidation preferences minority stockholders oppression proper purpose redemption rights

Venture Capital Term Sheets – Redemption Rights

Scott Edward Walker

Here are the issues I have addressed to date: common mistakes dealing with VC’s valuation liquidation preferences stock options exploding term sheets and no-shop provisions anti-dilution provisions dividends Board control protective provisions drag-along provisions pay-to-play and pull-up provisions conversion rights In today’s post, I examine the redemption rights of investors.

Should I Use My Investor’s Lawyer?

Scott Edward Walker

For example, he will explain to you how the liquidation preference works and run spreadsheets, if necessary, to show you how much money you will receive based on different sale scenarios; he will explain to you how the option pool works, including the founders’ significant dilution; and he will discuss what protective provisions are and other tricky legal terms, such as drag-along rights and anti-dilution provisions.

One Simple Paragraph Every Entrepreneur Should Add to Their Convertible Notes

Both Sides of the Table

When you do a convertible note with a cap that converts into the next round of funding one of the unintended consequences is that if you’re successful and raise at a larger price than your cap the early angels often get “multiple liquidation preferences” on their dollars in. When that initial note converts in stead of $500,000 liquidation preference they would get $2.5 They get their full investment as a 1x liquidation preference.

Common Stock vs. Preferred Stock in Venture Funding Transactions

Growthink Blog

The question is whether they need to issue common or preferred stock. The answer depends on how and what rights are defined in the preferred stock. The liquidation preference means what is sounds - namely that preferred stock holders with this right get all of their money back (i.e.

Founders – Use Your Down Round To Clean Up Your Cap Table

Feld Thoughts

I’ve seen every imaginable type of liquidation preference structure, pay-to-play dynamic, preferred return, ratchet, share/option bonus, option repricing, and carveout. I suffered through the next financing after implementing a complex structure, or a sale of the company, or a liquidation. Then use the down round to clean up your preference overhang. When I see a carveout being proposed these days, I know there’s a liquidation preference problem.

Office Hours at SXSW

The Startup Lawyer

If you want to discuss liquidation preferences, vesting schedules, or anything startup-related, I’ll be holding an office hour session this Friday March 7th from 130-230pm at UP Global’s SXSW Startup Oasis. The office hour portion of Startup Oasis is blocks of time where you can meet with mentors across a diverse range of skill sets. […]. Startup Lawyer

The Truth About Convertible Debt at Startups and The Hidden Terms You Didn’t Understand

Both Sides of the Table

To better understand the arguments for / against convertible equity I suggest you read my posts on those topics: Is convertible debt preferable to equity? Because convertible debt deals often have both a ‘full ratchet’ and often have ‘multiple liquidation preferences’ “ Yup. ” And some seed stage investors told me, “I prefer not to fight over price now. Convertible Notes Also Can Have Multiple Liquidation Preferences.

Convertible Debt Revisited

ithacaVC

The punishment comes in the form of “unjust” liquidation preference that the note holders end up with when they convert at a valuation cap that is way lower than the valuation of the actual round. The “unjust” liquidation preference comes in when the valuation cap price applies (it also applies a bit with a discount that is large). Each share of Series A will have a liquidation preference of $1.00 (assuming 1X preference, which is normal).

Want to Know How VC’s Calculate Valuation Differently from Founders?

Both Sides of the Table

Things like “ participating preferred stock &# in legalese unsurprisingly never actually call out, “hey, this is the participating preferred language.&# We got a3x participating liquidation preference with interest (not participating with a 3x cap, but 3x participating.

Unicorpse

Feld Thoughts

Some will demonstrate strategically justifiable metrics and have fantastic ‘up round’ exits; others may see liquidation preferences kick in which will negatively impact founders and employees; others may fulfill the adage “IPO is the new down round” , which has been the case for more than half of the public companies on our list. The current usage of the word unicorn makes me tired. I could rant about it for a while, but that would make me tired of myself ranting about it.

The Pre-money vs. Post-money Confusion With Convertible Notes

Feld Thoughts

Or, if you just want the paragraph, it’s: “If this note converts at a price higher than the cap that you have been given you agree that in the conversion of the note into equity you agree to allow your stock to be converted such that you will receive no more than a 1x non-participating liquidation preference plus any agreed interest.”. As an angel investor, I have never asked for a liquidation preference on conversion that is greater than the dollars I’ve invested.

One Book Every Entrepreneur and VC Should Own

Both Sides of the Table

To this day I’m still surprised how few CEOs really understand the differences between 2x liquidation preference and a liquidation preference with a 2x cap. Or what “participating preferred&# stock is and how it can screw you. Liquidation preferences never say things like “participating preferred&# although we all talk about it. This article originally ran on TechCrunch.

Bad Notes on Venture Capital

Both Sides of the Table

At an accelerator … Me: Raising convertible notes as a seed round is one of the biggest disservices our industry has done to entrepreneurs since 2001-2003 when there were “full ratchets” and “multiple liquidation preferences” – the most hostile terms anybody found in term sheets 10 years ago. I know how to structure around that to protect the founders from getting screwed on a multiple liquidation preference. This week.

A first-time founder’s guide to term sheets: Equity investments, continued

The Next Web

The terms Liquidation preference: a very important clause… This story continues at The Next Web. Andrej Kiska is an Associate at Credo Ventures. If you haven’t read the first part on equity term sheets, I strongly recommend doing so before moving on. For a general introduction to term sheets and the trade-off between high valuation and complex investment structure, please refer to the introductory post to the guide.

Want to Raise Venture Capital More Easily? Clean Up Your Own Shite First

Both Sides of the Table

That means that the likely have a minimum of $15 million in liquidation preferences. It will usually be higher because the liquidation preference has a dividend so if the deal is long in the tooth assume that the liquidation preference might be $20-22 million.

Selling your company for less than expected?

Berkonomics

Does the board declare dividends upon the preferred stock invested in order to increase the amount paid out to the preferred – at the expense of the common – shareholders, which usually includes the founder(s)? Is there a liquidation preference in place where the preferred investors can take a multiple of their investment, (twice or three times the amount) from a sale before the common shares receive anything? The liquidity event and beyond

The Corrosive Downside of Acquihires

Both Sides of the Table

If the money comes from professional investors it usually has a “liquidation preference” meaning that their money comes out before the founders or common stock. (If That’s why liquidation preferences exist – downside protection. For the past 5 years or so Google, Facebook and a handful of tech industry giants have been quietly buying scores of early-stage startups for their talent. And to keep up with the Jones’s it seems that Yahoo!

Walker Twitter Highlights: August 11th – September 8th

Scott Edward Walker

1 “Given how important they are, it’s surprising that liquidation preferences aren’t discussed more.” I’m using Twitter as a form of micro-blogging to share interesting articles, posts and podcasts relating to entrepreneurship and startups, M&A and legal issues. Below are my five most popular tweets for the past four weeks. Cheers, Scott. Top 5 Tweets. Quora: “What is the best piece of advice your mentor gave you before you founded your startup?”

Management Carve Out Plans

ithacaVC

This typically results when the company has raised a lot of money and the preferred stock liquidation preference would absorb an out sized portion of the exit proceeds. The second ( Liquidity_Bonus_Plan_-_Board_Meeting_Slides ) is a power point presentation that a startup board might review when adopting a plan. I have posted a few times on management carve out plans (back in February 2011 and November 2011 ; wow, time flies!!).

What is appropriate for Investor’s Contracts?

Gust

So my suggestion here is that (a) you accept the fact that in exchange for the 15K investment you are paying a 20K liquidation preference and 10% of the gross revenue, and that such payments and repayment will inure to the benefit of your investor and his estate, and (b) that you immediately go to a lawyer, and have the lawyer re-draft your agreement to supersede the home-grown one that you are now using.

Unicorn deals – not that heavily structured

The Equity Kicker

All of the deals had a liquidation preference of 1x or more. However, few of the deals went beyond a simple 1x non-participating preference share. I always wondered if companies were accepting multiple liquidation preferences in exchange for high valuations, but that was only the case in 3% of the deals analysed. Last May law firm Fenwick and West published an analysis of the 37 US unicorn deals that happened in the twelve months ending 31st March 2015.

6 Of The Best Reasons For Declining Investor Funding

Startup Professionals Musings

These normally include what percentage of the company the investor now owns, how and when tranches of money will be delivered, and even how and when you can sell your own shares (liquidation preferences). As an angel investor to startups, I’m still surprised to find entrepreneurs who expect investors to give them money, and assume no strings attached. Would you do that if it was your money?

Raise the right amount of money for your opportunity

The Equity Kicker

Otherwise the investors won’t make the multiple on their investment that they want and after liquidation preferences are paid the amount left for the entrepreneur may well also be disappointing. An example to illustrate: Company exits for £20m having raised £1m for 33% of the company in a 1x liquidation preference – the investor gets £8.3m

7 Investor Term Sheet Demands Startups Need Not Fear

Startup Professionals Musings

Investors typically demand preferred stock, to give themselves certain voting and liquidation privileges over later shareholders. Preferred shares are not possible with a limited liability corporation (LLC), so expect to convert to a C-corp to get an equity investment. Investor liquidation priority. Investors want a contract preference to get their total investment back first in any company sale, to prevent founders who are struggling from deciding to sell at a loss.

6 Unexpected Burdens That Come With Outside Investors

Startup Professionals Musings

These normally include what percentage of the company the investor now owns, how and when tranches of money will be delivered, and even how and when you can sell your own shares (liquidation preferences). As an angel investor to startups, I’m still surprised to find entrepreneurs who expect investors to give them money, and assume no strings attached. Would you do that if it was your money?

Accepting Outside Investors? Here Are 5 Things to Watch Out for in Your Contract

Up and Running

Preferred versus common shares. Assuming you’re considering an offer in which the investor is making a traditional equity investment (as a reminder, this is how most of the Sharks do it), the next important clause is to look at whether the shares the investor is taking are preferred or common shares. They can buy common shares or preferred shares. Liquidation preference.

Top five typical frustrations and confusions in the fundraising process

The Equity Kicker

What on earth does this termsheet mean with it’s liquidation preferences, anti-dilution and protective provisions? For example, liquidation preferences are financial structures whereby rather than just getting a share of the company investors get their money back first and then get a share of the company on top. If you’ve been paying attention you will know that Nicholas Lovell and I are writing a book for entrepreneurs who want to raise venture capital.