The liquidation preference is a protection mechanism granted to the investors that limits their investment risk into the company.
In the event of a company exit - buyout, IPO, bankruptcy proceedings - the liquidation preference clause allows to distribute the proceeds in priority to the investors before the other shareholders of the company, allowing them to get (up to) their investment back.
What types of liquidation preference mechanism exist on the market?
- x1 non-participating (market standard):
If the amounts distributed are lower than the amount invested by the investors, the latter are then served in priority up to the amount they have invested in the company (x1) and then the balance will be distributed only among the other shareholders (non-participating).
- x1 participating:
Once their initial investment has been recovered in priority, the investors can also receive the rest of the distributed proceeds, alongside the other shareholders (participating).
From a legal perspective, this mechanism detailed in the shareholders' agreement works through the issuance of new preferred shares to the investors, allowing them to be reimbursed in priority (up to their initial investment) before the other shareholders holding ordinary shares.
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