Term sheet clauses
Also called liq pref, 1x preference
A liquidation preference is the amount an investor is paid out of exit proceeds before common shareholders receive anything, normally expressed as a multiple of the money they invested.
A 1x preference means the investor gets their money back first. A 2x preference means twice the amount invested comes off the top before anyone else is paid. The multiple is the single most important number in the term after valuation.
Preferences stack by round. In a company that has raised a seed, a Series A and a Series B, each class has its own preference, and the order in which they are paid is set by whether the structure is stacked or pari passu.
Stacked, or standard, seniority pays the most recent round first, then the one before it, and so on. Pari passu pays all preferred classes at the same time, sharing pro rata if there is not enough to cover everyone.
In a strong exit the preference is irrelevant, because every class does better converting to common. It bites in the middle, where the company sells for more than it raised but not by a wide margin. That is where a stacked 1x across several rounds can consume most of the proceeds.
Anyone modelling an exit should build the full waterfall rather than assuming ownership percentages translate into payout percentages. They frequently do not.
1x non-participating is the market standard for healthy early-stage rounds. Anything above 1x, or participating, shifts value away from common shareholders.
Stacked pays later rounds before earlier ones. Pari passu pays all preferred classes at once, sharing pro rata if proceeds are insufficient.
In a large exit investors convert to common because that pays more, so the preference has no practical effect. It matters most at modest exit values.
Brouky tracks 43,000+ investors and the companies they have actually funded. Browse the investor directory, or see who backs a given sector, from fintech to biotech.