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.”

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.

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

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.

Everyone Needs A Diversion

Feld Thoughts

We’ve updated our Foundry Group web site with the new Liquidation Preference beer photo. Foundry Group beer diversion i'm a vc liquidation preference websiteEveryone needs a diversion.

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.

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? 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

VC Issues due diligence exploding term sheets founders Fred Wilson investors' option liquidation preferences no shop Rand Fish redemption rights startup vc VC term sheet venture capital

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.

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.

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.

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.

Unicorpse

Feld Thoughts

As an investor, would I rather own 30% of a company that is acquired for $300m in cash that had only raised $10m or 2% of a company with a paper value of $1b and $200m of liquidation preferences? The current usage of the word unicorn makes me tired.

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.

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? ” And some seed stage investors told me, “I prefer not to fight over price now. million of liquidation preferences.

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.

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.

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.

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).

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.

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.

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.

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.

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).

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

Up and Running

Preferred versus common shares. They can buy common shares or preferred shares. That’s because preferred shares operate under a completely separate set of rules (which will be defined in the investment documents) than your shares. Liquidation preference.

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!!).

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.

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.

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.

The Silliness Of Recapping Seed Rounds

Feld Thoughts

It usually happens in a later round, when the company is in fact worth much less than the liquidation preference overhang and insiders use a pay-to-play and a low valuation to reset the preferences and the cap table. Here’s the scenario. A company raises $1m of seed money from angels in a convertible note with a $6m cap.

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).

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.

Equity for Early Employees in Early Stage Startups

SoCal CTO

There's also the aspect that the equity that you typically get as part of equity compensation is behind other equity in preference and thus effectively has lower value.

What are the regulatory barriers preventing the emergence of a liquid market for equity in seed stage startups?

Gust

In my own portfolio I have companies that are generally perceived to be extremely successful with high profile customers and lots of sales…but they just happen to have a liquidation preference ladder of $25 million! Parts of the answer are that (a) there are enormous regulatory requirements relating to secondary markets, and (b) there are no analysts tracking private company stocks.