Liquidation preference

Worked example

A worked example of a payout waterfall (illustrative figures):

1. An investor put $20 million into a company for preferred shares representing 20% ownership, with a standard 1x non-participating liquidation preference.
2. At exit, the company sells for $60 million. The preferred investor compares two options: take the $20 million preference, or convert to common and take 20% of $60 million ($12 million) — and takes the larger number, the $20 million preference.
3. The remaining $40 million ($60M − $20M) is split among common shareholders (including any secondary buyers who bought common stock) according to their ownership percentages.
4. If the exit had instead been $150 million, the preferred investor would convert to common instead (20% of $150M = $30M, more than the $20M preference), and the waterfall changes completely — which is exactly why a secondary buyer of common stock needs to model exit scenarios across a range of values, not just the current valuation, before pricing a purchase.