Term sheets, clause by clause
Liquidation preferences
Who gets paid what when your startup sells.
When you raise venture money, your investors don’t buy the stock you hold. They buy preferred stock — a separate class of shares with extra rights attached. The right that matters most on the day your company is sold is the liquidation preference: a claim to be paid first, before you and your team, out of the sale price.
Here is the situation this lesson is built around. Your company, Meridian Robotics, raised $10 million from Basalt Ventures for 25% of the company. Eighteen months later, an acquirer offers $30 million. The announcement goes out, everyone celebrates — and then someone asks how the $30 million actually splits.
The answer lives in one clause. By the end you’ll be able to read that clause, compute the split at any sale price, and know which words in it are worth negotiating.
What you’re getting
Four sections and a final
- Why your investor stands ahead of youWhat the preference is, why it exists, and how to split a sale price under the standard 1× clause.
- Take the $10M, or convert?The choice every preferred investor makes at a sale, and the price where their answer flips.
- Non-participating, participating, cappedThe one word that decides whether the investor takes one bite or two — and what a cap really caps.
- Two investors in lineWhat happens to your share when a Series B lands on top of the Series A, and which terms to push back on.
Section 1
Why your investor stands ahead of you
Start with why the clause exists at all. Basalt paid $10 million for a quarter of Meridian. That price says Basalt thinks the whole company is worth $40 million. But suppose things go wrong and Meridian sells for $12 million a year later. If the money were split purely by ownership, Basalt would get 25% — $3 million — and the founders, who paid nothing for their shares, would split $9 million. Investors won’t sign up for that, so nearly every venture deal adds a floor: before common stock sees a dollar, the investor gets its money back.
That floor is the liquidation preference. Despite the name, it isn’t only about shutting the company down — the documents define a sale or merger as a deemed liquidation event, so the clause fires precisely when you succeed in selling the company. The standard version reads like this:
1× non-participating preference
Non-participating means either/or: the investor takes this floor or converts its shares to common — never both. Language modeled on the NVCA model documents most US deals start from (last revised 2025–2026).
In the event of any liquidation, dissolution or winding up (including a Deemed Liquidation Event), the holders of Series A Preferred shall be entitled to receive, prior and in preference to the holders of Common Stock, an amount equal to one times the Original Purchase Price…
“1×” is the multiple: the preference equals one times the money invested. A 2× clause would double the floor. As of mid-2025, about 98% of new priced rounds — financings that set a share price, the kind this term sheet opens — carry a 1× multiple (Carta deal-terms data).
What each side gets
The investor gets insurance: in a disappointing sale, their money comes back first. You get their $10 million at a price that values your company at $40 million. The preference is part of what you sold to get that valuation.
Now apply it to the $30 million offer from the announcement. Basalt has two possible ways to be paid — its ownership percentage, or its preference — and the either/or clause lets it take whichever pays more. That is the word that was missing from the opening question. Watch how each route splits the price.
The $30M sale, two ways to split it
Split by ownership alone — 25% / 75%
Split by the preference — $10M off the top
Basalt VenturesCommon — you and the team
The ruleBasalt takes whichever route pays more. $10M beats $7.5M, so the preference wins: Basalt $10M, common $20M. Your 75% of the company just became 67% of the money.
Section 2
Take the $10M, or convert?
The two bars you just compared are a real choice the clause hands the investor. Preferred stock can always convert into common stock — and at a sale, a non-participating investor picks one route or the other. Keep the preferred and take the preference, or convert to common and take the ownership percentage. The percentage route has a name you’ll see in every document: the as-converted value — ownership share × sale price, what the stock would be worth as common. Basalt takes whichever route pays more, every time.
Which route pays more depends only on the sale price. At $30 million the preference won. At some higher price, 25% of the sale must overtake the flat $10 million.
The flip you just found is the whole decision, drawn as a rule:
The investor’s choice at a sale
$40M is Meridian’s crossover: the price where 25% × price equals the $10M preference. Every deal has its own crossover — preference amount divided by ownership share.
Section 3
Non-participating, participating, capped
Everything so far assumed one word in the clause: non-participating. It means what you’ve seen — the investor takes the preference or converts, whichever is larger. The other version is participating preferred: the investor takes the preference back first and then also shares in everything left, pro rata — in proportion to its ownership — as if it had converted too. Founders call it the double-dip.
A cap limits the double-dip: participation stops once the investor’s total reaches some multiple of their investment — “participating with a 2× cap” stops at $20 million on a $10 million check. One sale price, three clauses, three payouts:
The same $60M sale under three clauses
One more wrinkle to the capped clause: the investor keeps the right to convert, so at a high enough price — where ownership × price beats the cap — even a capped participating investor converts, and the cap stops mattering.
As of mid-2025 the market has largely settled this fight in founders’ favor: participating preferred is rare in new early-stage deals, and about 98% of priced rounds use a plain 1× multiple (Carta). Participation still shows up in down markets and late rounds, though, so read for it every time.
Section 4
What happens with two investors in line
Eighteen months after the Series A, Meridian raises again: Crestline Capital puts in $20 million at a $100 million post-money valuation — the company’s value counting the new cash — so Crestline’s $20 million buys 20%. Its shares are newly created, which shrinks everyone else’s percentage by a fifth: Basalt’s 25% becomes 20%, and common’s 75% becomes 60%. Both investors have 1× non-participating preferences, so there is now $30 million of preference standing in front of the common stock.
A new question appears: when the sale price can’t cover both preferences, who gets paid first? Two conventions exist. Stacked (the “standard” order): the newest money is paid first — last in, first out. Pari passu (“on equal footing”): all preferred shares share the pot in proportion to their preference amounts. In 2025, about two thirds of deals with non-participating preferred used the stacked order (Carta).
$30M of preferences, one sale price
Stacked — Crestline is senior
Pari passu — shared pro rata
Crestline ($20M pref)Basalt ($10M pref)Common — you and the team
Notice what the $35M button shows: once the price clears the whole $30 million stack, the two orders pay out identically. Seniority only changes the split in disappointing exits, so settle it up front, while everyone still expects a good one. The flavor is worth the same attention: a participating Series B costs you at every exit price, not only the disappointing ones.
Closed book
The final
A different company this time, so the numbers are yours to work out. Reference locks while this is open. Answer everything, then submit — nothing is scored until you do.
Where you stand
What you can do now
These fill in as you get things right, in this browser session only. Nothing is stored.
What this lesson left out
- Option pools and carve-outs. A real sale also routes money to option holders and, sometimes, a management carve-out negotiated at the sale.
- Anti-dilution and redemption. Other preferred-stock rights that change the math in down rounds — different clauses, different lesson.
- IPOs. In a public offering the preferred typically converts to common automatically, and preferences fall away.
- Convertible instruments. SAFEs and notes get preferences only once they convert into priced preferred stock.
Educational material, not legal advice. Companies and firms named here are fictional. Market statistics are Carta deal-terms data as of mid-2025; clause language follows the NVCA model documents as revised 2025–2026. Built with AI assistance — have real documents read by counsel.