Participating vs non-participating preferred stock in liquidation preference

What is liquidation preference?

Liquidation preference refers to preferred stockholders’ rights to receive a certain amount for the preferred stock they hold in preference to common stockholders in the event that a company goes into liquidation.

What is non-participating preferred stock?

Non-participating preferred stock means in the event of a liqudiation, preferred stockholders will receive a certain amount before common stockholders (usually a multiple of the purchase price, e.g., 1 times or 2 times), and no more. All remaining proceeds will go to common stockholders.

A sample clause in a venture capital term sheet on non-participating liquidation perference may go like this:

In the event of a liquidation event, the preferred shareholders will be entitled to receive in preference to common shareholders an amount equal to 2 times the purchase price per share, plus declared and unpaid dividends (the “Initial Payment”). After the Initial Payment has been made in full, any assets remaining shall be distributed to common shareholders on a pro rata basis.

What is participating preferred stock without a cap?

This means that in the event of a liqudiation, preferred stockholders will receive a certain amount before common stockholders (usually a multiple of the investment amount, e.g., 1 times or 2 times), and then they will participate in the distribution of the remaining proceeds with common stockholders until everything is gone.

A sample clause in a venture capital term sheet on participating liquidation perference with a cap may go like this :

In the event of a liquidation event, the preferred shareholders will be entitled to receive in preference to common shareholders an amount equal to 2 times the purchase price per share, plus declared and unpaid dividends (the “Initial Payment”). After the Initial Payment has been made in full, any assets remaining shall be distributed to the preferred shareholders (on an as-converted basis) and common shareholders on a pro rata basis.

What is participating preferred stock with a cap?

This means that in the event of a liqudiation, preferred stockholders will receive a certain amount before common stockholders (usually a multiple of the purchase price, e.g., 1 times or 2 times), and then they will participate in the distribution of the remaining proceeds with common stockholders until the preferred stockholders receive an aggregate of [x] times the purchase price (e.g., 5 times). Therefore, the total amount preferred stockholders will get is capped.

A sample clause in a venture capital term sheet on participating liquidation perference with a cap may go like this:

In the event of a liquidation event, the preferred shareholders will be entitled to receive in preference to common shareholders an amount equal to 2 times the purchase price per share, plus declared and unpaid dividends (the “Initial Payment”). After the Initial Payment has been made in full, any assets remaining shall be distributed to the preferred shareholders (on an as-converted basis) and common shareholders on a pro rata basis, until the preferred shareholders receive an aggregate amount of 5 times the purchase price

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1. How to Calculate Liquidation Preference of Preferred Stock in a Venture Capital Financing?
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3. What is Series A Convertible Preferred Stock Funding and Financing in a Venture Capital Investment?
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