<story><title>Sell for half a billion and get nothing (2021)</title><url>https://www.fundablestartups.com/blog/half-a-billion</url></story><parent_chain><item><author>lpolovets</author><text>I&amp;#x27;ll throw out a VC&amp;#x27;s perspective on liquidation prefs:&lt;p&gt;1) I think 1x is very fair and meant to protect investors from bad company behavior. If you didn&amp;#x27;t have 1x preference, this would be an easy way for an unscrupulous founder to cash out: raise $X for 20% of the company, no liquidation preference. The next day, sell the company and its assets ($X in cash) for, say, 0.9x. If there&amp;#x27;s no liquidation preference, the VC gets back 0.18x and the founder gets 0.72x, even though all that the founder did was sell the VC&amp;#x27;s cash at a discount the day after getting it.&lt;p&gt;2) &amp;gt;1x liquidation preferences are sometimes the founder&amp;#x27;s fault and sometimes the VC&amp;#x27;s fault. Sometimes it&amp;#x27;s an investor exploiting a position of leverage just to be more extractive. That sucks. But other times it&amp;#x27;s a founder intentionally exchanging worse terms for a higher&amp;#x2F;vanity valuation.&lt;p&gt;For example, let&amp;#x27;s say a founder raised a round at $500m, then the company didn&amp;#x27;t do as well as hoped, and now realistically the company is worth $250m. The founder wants to raise more to try to regain momentum.&lt;p&gt;A VC comes and says &amp;quot;ok, company is worth $250m, how about I put in $50m at a $250m valuation?&amp;quot;&lt;p&gt;Founder says &amp;quot;you know, I really don&amp;#x27;t want a down round. I think it would hurt morale, upset previous investors, be bad press, etc. What would it take for you to invest at a $500m+ valuation like last time?&amp;quot;&lt;p&gt;VC thinks and says &amp;quot;ok, how about $500m valuation, 3x liquidation preference?&amp;quot;&lt;p&gt;The founder can now pick between a $250m and a 1x pref, or $500m and a 3x pref. Many will pick #1, but many others will pick #2.&lt;p&gt;It&amp;#x27;s a rational VC offer -- if the company is worth $250m but wants to raise at $500m, then a liquidation preference can bridge that gap. The solution is kind of elegant, IMHO. But it can also lead to situations like the one described in the article above where a company has a good exit that gets swallowed up by the liquidation preference.&lt;p&gt;3) generally both sides have good lawyers (esp. at later stages of funding), so the liquidation preference decision is likely made knowingly.&lt;p&gt;Related to #3, if you&amp;#x27;re fundraising, please work with a good lawyer. There are a few firms that handle most tech startup financings, and they will have a much better understanding of terms and term benchmarks than everyone else. Gunderson, Goodwin, Cooley, Wilson Sonsini, and Latham Watkins are the firms I tend to see over and over.</text></item></parent_chain><comment><author>smohnot</author><text>Leo does a great job explaining why VC&amp;#x27;s want liquidation preferences.&lt;p&gt;But founders&amp;#x2F;employees want them too! With all the crazy founder-friendly deals of 2021, I never heard of one in the US without a liquidation preference.&lt;p&gt;Why? Liquidation preferences allow the VC bought securities to be treated as &amp;quot;preferred&amp;quot; and reduce the common stock price in the 409a valuation report, allowing early employees to get options at low prices.&lt;p&gt;If VC&amp;#x27;s invested in common stock the strike prices would be much higher, making it less lucrative to be an early employee.&lt;p&gt;In parts of Europe there is different tax treatment for options and employees generally don&amp;#x27;t own as many shares due to it... and some of those companies don&amp;#x27;t have liquidation preferences. I believe Klarna (Sweden) doesn&amp;#x27;t have preferred shares, meaning the huge swing in valuation they had over the past few years is not as bad as it seems.&lt;p&gt;TBH the whole 409a thing is a charade &amp;amp; we probably need to clean up how we do accounting &amp;amp; taxes but until we do, preferred shares are here to stay.</text></comment>
<story><title>Sell for half a billion and get nothing (2021)</title><url>https://www.fundablestartups.com/blog/half-a-billion</url></story><parent_chain><item><author>lpolovets</author><text>I&amp;#x27;ll throw out a VC&amp;#x27;s perspective on liquidation prefs:&lt;p&gt;1) I think 1x is very fair and meant to protect investors from bad company behavior. If you didn&amp;#x27;t have 1x preference, this would be an easy way for an unscrupulous founder to cash out: raise $X for 20% of the company, no liquidation preference. The next day, sell the company and its assets ($X in cash) for, say, 0.9x. If there&amp;#x27;s no liquidation preference, the VC gets back 0.18x and the founder gets 0.72x, even though all that the founder did was sell the VC&amp;#x27;s cash at a discount the day after getting it.&lt;p&gt;2) &amp;gt;1x liquidation preferences are sometimes the founder&amp;#x27;s fault and sometimes the VC&amp;#x27;s fault. Sometimes it&amp;#x27;s an investor exploiting a position of leverage just to be more extractive. That sucks. But other times it&amp;#x27;s a founder intentionally exchanging worse terms for a higher&amp;#x2F;vanity valuation.&lt;p&gt;For example, let&amp;#x27;s say a founder raised a round at $500m, then the company didn&amp;#x27;t do as well as hoped, and now realistically the company is worth $250m. The founder wants to raise more to try to regain momentum.&lt;p&gt;A VC comes and says &amp;quot;ok, company is worth $250m, how about I put in $50m at a $250m valuation?&amp;quot;&lt;p&gt;Founder says &amp;quot;you know, I really don&amp;#x27;t want a down round. I think it would hurt morale, upset previous investors, be bad press, etc. What would it take for you to invest at a $500m+ valuation like last time?&amp;quot;&lt;p&gt;VC thinks and says &amp;quot;ok, how about $500m valuation, 3x liquidation preference?&amp;quot;&lt;p&gt;The founder can now pick between a $250m and a 1x pref, or $500m and a 3x pref. Many will pick #1, but many others will pick #2.&lt;p&gt;It&amp;#x27;s a rational VC offer -- if the company is worth $250m but wants to raise at $500m, then a liquidation preference can bridge that gap. The solution is kind of elegant, IMHO. But it can also lead to situations like the one described in the article above where a company has a good exit that gets swallowed up by the liquidation preference.&lt;p&gt;3) generally both sides have good lawyers (esp. at later stages of funding), so the liquidation preference decision is likely made knowingly.&lt;p&gt;Related to #3, if you&amp;#x27;re fundraising, please work with a good lawyer. There are a few firms that handle most tech startup financings, and they will have a much better understanding of terms and term benchmarks than everyone else. Gunderson, Goodwin, Cooley, Wilson Sonsini, and Latham Watkins are the firms I tend to see over and over.</text></item></parent_chain><comment><author>babyshake</author><text>This is a good explanation. However, if you do take on liquidation prefs, you should be open with other parties (employees) who are affected. I have never, ever experienced employers who have volunteered this information. I have also been told, when I asked about liquidiation prefs, that they had no way of determining whether or not that provision existed in their investment terms (!).</text></comment>