A Founder’s Guide To Understanding Liquidation Preference

Liquidation is the process of closing a business and distributing its assets among stakeholders, creditors, and rightful claimants. In the event of a corporate liquidation, preferred shareholders recover their investments first, prior to all other shareholders, in the process known as Liquidation Preference. Liquidation preference is a form of protection for investors as it guarantees them a certain minimum payment, regardless of the company’s valuation at exit. Investors can choose between non-participating and participating liquidation preference.

Non-participating liquidation preference allows investors to receive predetermined returns without any share in the surplus. In contrast, participating liquidation preference allows investors to receive predetermined returns as well as a share of the surplus proceeds based on their shareholding.

Standard Seniority Liquidation Preference is followed by most early-stage companies, where liquidation preferences are honored in reverse order from the latest investment round to the earliest. Pari-Passu Seniority gives all preferred investors equal seniority status, meaning that all investors would share in at least some part of the proceeds. Tiered Seniority is a hybrid between standard and pari-passu seniority, with investors grouped into distinct seniority levels.

Investors ask for liquidation preference to protect themselves, particularly if a company fails to meet expectations and sells or liquidates at a lower valuation than anticipated. Liquidation preferences are expressed as a multiple of the initial investment and are most commonly set at 1X. In the event of liquidation, investors receive the full amount of their investment before any other equity holders or their share in the liquidation proceeds on a pro-rata basis, whichever is more. Understanding liquidation preference is important for founders to negotiate well with potential investors.

About the Author
Koustubh Athavale
Koustubh Athavale
Senior Associate | Legal | [email protected]

Provides expertise in commercial contracts, dispute resolution, and data privacy. Leverages extensive experience in the startup ecosystem to deliver tailored legal solutions for diverse business needs.

Nikita Sukhathankar
Nikita Sukhathankar
Senior Associate | Transactions | [email protected]

Brings deep expertise in transactions, regulatory compliance, and corporate law. Specializes in venture capital, private equity, and complex deal structuring, helping startups navigate financial and legal frameworks with ease.

We Are Problem Solvers. And Take Accountability.

Related Posts

Liabilities of Directors Under the Companies Act, 2013 – Duties Explained
Liabilities of Directors Under the Companies Act, 2013 – Duties Explained

Directors play a critical role in shaping the governance and operations of a company, making decisions that affect both the...

Learn MoreLearn More
India’s Key Trade Schemes: A Quick Guide for Exporters & Importers
India’s Key Trade Schemes: A Quick Guide for Exporters & Importers

India's Foreign Trade Policy (FTP) serves as the cornerstone for the nation's engagement with the global economy, outlining strategies and...

Learn MoreLearn More
Understanding Accounting and Taxation – A Detailed Guide
Understanding Accounting and Taxation – A Detailed Guide

Accounting and taxation services encompass essential business functions focused on recording financial transactions, preparing accurate financial statements, and ensuring compliance...

Learn MoreLearn More

For Customer Support

Mumbai | Delhi |
Bangalore | GIFT City

Speak to Us!

We respond within 60 minutes.

    Your information is confidential and secure

    For Customer Support

    Mumbai | Delhi |
    Bangalore | GIFT City

    Fill out the form to unlock the full report!

    Image