Reference · Rights & restrictions
Liquidation preference
The right of preferred holders to get their money back (sometimes a multiple of it) before common holders receive anything.
Worked example
A worked example of a payout waterfall (illustrative figures):
- An investor put $20 million into a company for preferred shares representing 20% ownership, with a standard 1x non-participating liquidation preference.
- 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.
- The remaining $40 million ($60M − $20M) is split among common shareholders (including any secondary buyers who bought common stock) according to their ownership percentages.
- 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.
Where this trips people up
The dangerous assumption is that ownership percentage equals share of proceeds. Preferences sit ahead of common stock, so in a modest exit the preference stack can absorb most or all of the value before common holders receive anything. Employees comparing a paper valuation with their percentage holding frequently overestimate what an exit would actually pay them.
Frequently asked
How do I find out what preferences sit above my shares?
Ask for the capitalisation table and the preference terms — companies increasingly share a summary with employees. Without knowing the size and seniority of the stack, any calculation of what your shares are worth in an exit is guesswork.
Does a high valuation protect common shareholders?
Only if the exit clears the stack comfortably. A high valuation achieved with a large preference overhang can still leave common holders with very little in a mid-range outcome.
See the full glossary entry, or browseevery term.