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Liquidation preference is the number one way that founders end up with nothing. Works like this: VC invests $1m with a, say, 5x liquidation preference then if they company sells for, say $6m the VC gets the first $5m and the remaining $1m is split according to equity. http://www.gabrielweinberg.com/ has some really, really good articles on this kind of thing.


But if the company sold for less than $5m, the founders would get nothing?

Probably ignorance here, but if the company sold for less, say $4m are the founders now in debt for the remainder of the 5x agreement?


So the founders who own majority of the company, can be outnumbered on the board and have little influence over "strategic tactical" decisions etc?


yes at $5m they will get nothing, but at $4m they won't be in debt. 5x is really a rip-off, but 2x (double-dip) is quiet common.

Liquidation preference at its core is an instrument to protect the investor. Imagine the following scenario:

An Investor gives you $1m for 50% of your company. A year later it sells for $1m (because it wasn't a hit). The investor just lost $500k you made +$500k.


Simply put, funding rounds are often a stack. Each round of new money typically moves existing investors to a lower priority.

Founders are first in.




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