Liquidation Preference

A liquidation preference is a right given to a class of preferred stock allowing the owners of that class of stock to receive proceeds in a liquidation before the owners of other classes of stock (common stock, for example) receive any proceeds. Proceeds is another way of saying money. A liquidation could the purchase of the company, whether by an acquisition or merger, or a bankruptcy of the company. The liquidation preference right is set forth in the stock purchase documents entered into by and between the preferred stockholders and the company. Preferred stockholders often won’t invest in the company as preferred stockholders unless given this type of right. Common stockholders in a company, who are often the initially founders of the company at startup, will not have a similar right as the preferred stockholders. The liquidation preference is one of the reasons, amongst others, why some founders of startups are hesitant to take money from outside investors, like angel investors or venture capitalists. The strings that are often attached to that investment money can be so burdensome or unfair that it may make little sense to take the money at all. Instead, startup founders may find it more advantageous to grow more slowly with their own capital and on their own equity terms.