In my discussions and negotiations with Pre-Seed / Seed stage start-ups I get strong push from founders not to have liquidation preference right. In my opinion it is a must to have right for any start-up investor.
Because as an investor, I’d at least want to get my money back before the founders share the remaining proceeds. An example explaining a one time non participation liquidation preference:
Startup A receives an investment of EUR 100,000 from VC1 at a post-money valuation of EUR 1,000,000. VC1 owns 10%. Time pass, no new investment is received, 5 years in the founders receive an offer to sell 100% of the company for EUR 800,000. Founders are tired of running the business, they believe this is a good opportunity and agree to sell. If there would be no liquidation preference, the investor would get only EUR 80,000 (800,000 x 10%). It means that VC1 has lost EUR 20,000 while the founders have netted EUR 720,000 returns to their bank accounts. With a one time non-participating liquidation preference, the distribution would be as follows – VC1 gets its money back, the full EUR 100,000, while the remaining EUR 700,000 are distributed proportionately to the founder equity holdings. VC1 is no longer participating in the further distribution.
However, if you have a one-time participating liquidation preference, this would mean that the VC1 shall participate proportionately in further distribution the EUR 700,000. Which end result in VC1 receiving EUR 100,000 and then also EUR 70,000 (700,000 x 10%).
The image attached illustrates different variation of distribution based on different types of liquidation preferences.
Relating is not the same as equating.
Before you scroll away from this, think about it: you can relate to someone’s experiences without equating their pain to yours, because you don’t know what they’re feeling and it’s not up to you to tell them how to feel. You can however, relate a similar experience without being cruel about it, empathise with them without diminishing their experience or pain, and be mindful enough to avoid playing pain olympics.
Everyone has different thresholds for different types of pain - wouldn’t it make sense that we should be mindful enough to avoid forcing our feelings, insecurities or standards on others? Where’s our freedom to feel, or even the possibility of processing these feelings without it?