Order of payment for preferred shareholders
Liquidation preference is a right attached to preferred shares that determines who gets paid first, and how much, when a company is sold or liquidated. A 1x preference means the preferred holder gets back at least the amount they invested before any proceeds go to ordinary shareholders, including founders and employees with vested options, a right that is negotiated as part of the term sheet.
Non-participating means that after taking their preference, the preferred holder does not also share in the remaining proceeds unless they choose to convert to ordinary shares instead and take their pro rata share of everything. Participating means the preferred holder takes their preference and then also shares in the remaining proceeds alongside ordinary holders, sometimes described as double dipping, which materially changes what founders and employees receive on an acquisition.
Non-participating payout for Liquidation Preference
An investor puts in EUR 2m for 20% of a company (post-money valuation EUR 10m) with a 1x non-participating preference. The company sells for EUR 8m. The investor chooses the better of two options: take their EUR 2m preference, or convert to ordinary shares and take 20% of EUR 8m (EUR 1.6m). Since EUR 2m is more than EUR 1.6m, they take the preference, leaving EUR 6m for ordinary shareholders, which is then split among holders of employee equity at exit.
If instead the company sells for EUR 30m, the investor compares EUR 2m (the preference) with 20% of EUR 30m (EUR 6m) if they convert. They convert, since EUR 6m is more, and ordinary shareholders share the remaining EUR 24m.
Participating preference payout for Liquidation Preference
Using the same EUR 2m for 20% deal, but with 1x participating preference, on an EUR 8m sale the investor takes their EUR 2m preference first, then also takes 20% of the remaining EUR 6m (EUR 1.2m), for a total of EUR 3.2m. Ordinary shareholders split the remaining EUR 4.8m. Participating preferred is more favorable to the investor than non-participating in every outcome, which is why it is less common in founder-friendly European markets.
Liquidation preference seniority in successive rounds
| Round | Amount raised | Typical seniority |
|---|---|---|
| Series B | EUR 15m | Paid first (most senior) |
| Series A | EUR 6m | Paid second |
| Seed | EUR 1.5m | Paid third |
| Ordinary shares (founders, employees) | n/a | Paid last |
Seniority stacking means that in a modest exit, later and larger rounds can absorb most or all of the proceeds before earlier investors or ordinary shareholders see anything.
Preference stack questions from founders
- Is 1x non-participating the market standard in Europe?
- It is the most common structure in mainstream European venture deals, though terms vary by fund, deal competitiveness, and market conditions.
- Can liquidation preference reduce what founders receive on a sale?
- Yes, particularly in a lower-value exit where preference stacks absorb a large share of proceeds before ordinary shareholders are paid.
- What is a capped participating preference?
- A middle-ground structure where the investor participates in the upside but only up to a defined multiple of their investment, after which they stop participating.
General information for founders, not legal or tax advice. Thresholds and rates change, so confirm the current position with an adviser in the relevant country before granting.