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How can the liquidation preference impact during an acquisition?

Especially if the acquisition comes at a lower price from the valuation that was established on the previous round of financing.

8 Replies

Arthur Lipper
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Arthur Lipper Entrepreneur
Chairman of British Far East Holdings Ltd.
The liquidation preference is one more reason not to view VC money favorably. The liquidation preference will not influence the acquirer but will determine how good the deal is for the equity holders. Arthur
Ian Shearer
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Ian Shearer Advisor
Executive Chairman at Parakeetplay
Well it depends on the circumstances. I have advised on deals where the Liquidation Preference meant that all shareholders (including management) outside the VCs took a bath. That can worry the Acquirers who usually recognize that buying an unhappy Management team is not a good idea so they build in a separate deal for the Management team, usually in the form of a retention bonus or something like that. These amounts can be significant because often the acquirer is very sympathetic to the Founder/ managers.
Laura Oliphant
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Laura Oliphant Advisor
Business Development and Venture Capital Professional
It depends. With a liquidation preference, your investors get their money out x their liquidation preference multiple before anyone else gets proceeds. Then (much of the time) they share in the remainder of the proceeds.

So, for example, if an investor invests $5M in your company with a 1x participating liquidation preference, and a $25M post money valuation, they own 20% of the company on a fully diluted basis.

Now, if your company sells for $10M, the proceeds split is as follows:

$5M to the investor to satisfy the liquidation preference +

20% of the remaining proceeds because they had participating preferred, in this case, that would be $1M.

So, the total proceeds would be $6M to the investor.

Now, that doesn't leave a whole lot for the employees, as others have said, a lot of the time the acquirer will offer retention packages. Also, sometimes, employees have voting power (in this case, they likely would), and so, can negotiate a carve out off the top. In this case, if the employees had a 20% carve out,the proceeds would look like this:

$2M off the top for the employees
$5M for the preference to the investor
20% of the remaining $3M to the investor, or $600k to the investor.
$2.4M to the holders of the common stock.




Arthur Lipper
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Arthur Lipper Entrepreneur
Chairman of British Far East Holdings Ltd.
The inherent assumption in liquidation preferences is that the company is created as a flipper, to be sold or acquired, rather than continuing as a sustainable and growing enterprise. Flippers are managed differently than keepers. If flipping is the objective then a VC can be helpful in causing that result. Arthur
Laura Oliphant
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Laura Oliphant Advisor
Business Development and Venture Capital Professional
Not explicitly, yes, there is an expectation of an exit, but you have to build a sustainable and growing enterprise to get an exit. I view the liquidation preference as a way of managing a VC's risk/return and founder's expectations/desires regarding valuation.
Michael Barnathan
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Michael Barnathan Entrepreneur • Advisor
Co-Founder of The Mountaintop Program, Google Alum
"lower price from the valuation that was established on the previous round of financing."

It's not a lower price than the valuation that is the problem, it's lower than the amount of the preference (often the amount raised, a 1x preference). In that case, the VC takes everything but the acquirer incurs no debt to the VC (keep in mind that VCs also typically negotiate rights of refusal for sales, however). In the case where the selling price falls above the amount raised, the VC gets the liquidation preference back, and the rest is split up according to the cap table. In a participating preferred round, the VC will also double dip from that split after the preference is satisfied.

These are a couple of the ways you can "successfully exit" a "billion dollar company" and still walk with nothing.
Laura Oliphant
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Laura Oliphant Advisor
Business Development and Venture Capital Professional
True, if you exit for an amount less than the liquidation stack. So, in my previous example, if the exit were to be for $5M and the liquidation stack was $5M, all of it would go to the investor. Now, sometimes the common stock holders and/ or management team have voting power, in that case, they can negotiate for a carve out. Also, acquiring companies may offer retention packages.
Laura Oliphant
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Laura Oliphant Advisor
Business Development and Venture Capital Professional
But, yes, this is a way that you can "successfully exit" a "billion dollar company" and still walk away with nothing. Several of the very high profile unicorns also have very high liquidation stacks, and it will be interesting to see what happens when they exit...
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