Liquidation preference
Preferred shareholders' right to receive a specified amount before common in a liquidation event. 1x non-participating is standard.
| 1x non-participating (standard) | Preferred receives 1x purchase price, then converts to common if more favorable |
|---|---|
| 1x participating | Preferred receives 1x purchase price AND then participates in remaining proceeds with common |
| Multiple preference (>1x) | Preferred receives more than original purchase price first (rare today) |
| Capped participating | Participating with a cap on total preferred recovery |
The standard 1x non-participating preference
The current US venture market standard for early-stage preferred stock is 1x non-participating. This means:
- At a liquidation event, each preferred share is entitled to receive its original purchase price (1x).
- The preferred holder can choose to take the preference amount OR convert to common and take the common share, whichever produces a higher return.
- Once the preferred either takes the preference or converts, the remaining proceeds are distributed to common shareholders pro rata.
The structure protects investors against losses (they get their money back first) while preserving founder economics on a strong exit (preferred converts to common and the founder retains a meaningful share of the upside).
Participating preferred: double-dipping
Under participating preferred, the holder receives the liquidation preference and participates pro rata with common in the remaining proceeds, without having to choose. A $5M participating preferred holder in a $50M exit would receive their $5M back plus their pro rata share of the remaining $45M.
Participating preferred is heavily favored by investors but creates a major dilution for founders. Modern term sheets often resolve this by 'capping' the participation at a multiple of the preference (e.g. participation stops once the preferred has received 3x its purchase price), or by simply not including participation at all.
The seniority stack
When multiple series of preferred exist, the liquidation preferences typically rank in reverse order of issuance: the most recent series (Series C) is paid first, then Series B, then Series A. This 'inverted stack' compensates later investors for taking risk at higher valuations.
Some financings use 'pari passu' ranking, where all preferred series are paid pro rata together. Pari passu is more common in seed-stage rounds and in international markets; senior-junior stacking is more common in US Series A and later.
Octelligence models the liquidation waterfall for any exit scenario, applying participation, caps, conversion choices, and seniority ordering across multiple preferred classes. Founders and counsel can see what each holder receives at every exit value.
See cap table scenariosFull preference stack, participation, caps, and conversion choices modelled automatically.