Liquidation Preference

Liquidation preference is used in VC contracts to specify the order and amount each investor get paid in a liquidation event such as a sale. Liquidation preference protects VCs by making sure they get their initial investments back before other parties. If the company is sold at a profit, liquidation preference can also put them first in line to claim the profits. VCs are usually repaid before holders of common stock and before the company's original owners and employees. Often, the liquidation preference can even be a "2x" or "3x" liquidation preference: that is, the VC first must receive 2 or 3x their original investment before all stockholders (including the VCs) in the private company start sharing the proceeds of a sale equally.