Liquidation Preference
A liquidation preference is a specific clause that dictates the payout order in the case of a corporate liquidation.
What is liquidation preference?
A liquidation preference determines who gets paid first and how much they get paid if a company must be liquidated. Investors or preferred shareholders are usually paid back first, meaning they have the highest liquidation preference, ahead of both the common stock and debt holders. These are most commonly used in venture capital contracts.
Why do companies have liquidation preferences?
Often, it is the investors that require the liquidation preference clause to protect their investments into the company. As it is inherently risky to make investments in the venture space, investors here want to do everything they can to protect their capital and this happens to be one of the best tools for them to do so.
What is a standard liquidation preference?
Liquidation preference can all have bespoke terms. The most common is to have a 1-2x liquidation preference, which means the investor must be paid back 1-2x their original investment, before other creditors are to be paid out.
