Raising venture capital can help startups grow faster—but it also introduces investor-friendly terms that can significantly impact founder outcomes. One of the most important (and often misunderstood) terms in any venture deal is the liquidation preference.
In 2025, with down rounds and tighter investor conditions becoming more common, understanding how liquidation preferences work is more important than ever. This guide breaks it down in plain terms.
What Is a Liquidation Preference?
A liquidation preference determines how investors get paid when a company exits—whether through an acquisition, IPO, or shutdown. It defines who gets paid first and how much they receive before common shareholders (like founders and employees) see any returns.
Liquidation preferences are most relevant in preferred stock deals—usually during priced equity rounds like Series A or later. They are designed to protect investors’ downside.
How Liquidation Preferences Work
Let’s say an investor puts €2M into a startup at a €10M pre-money valuation. They receive preferred shares with a 1x liquidation preference. If the company exits for €10M:
- The investor gets their €2M back first
- The remaining €8M is distributed to other shareholders (common stock)
If the company exits for only €2M, the investor gets the full €2M—founders and employees get nothing.
Common Types of Liquidation Preferences
1. 1x Non-Participating Preference (Most Common)
- Investor gets their original investment back first (1x)
- After that, the rest goes to common shareholders
2. 1x Participating Preference
- Investor gets their investment back first and then participates pro rata in the remaining proceeds
- Often called "double-dipping"
3. 2x or 3x Preferences
- Investor gets 2x or 3x their original investment before others get paid
- Often used in later-stage or high-risk deals
4. Capped Participation
- Participating preference with a cap (e.g., up to 2x total return)
- After the cap is hit, remaining funds go to common shareholders
Why It Matters for Founders
Liquidation preferences can significantly impact founder equity at exit—even when valuations grow.
If a company raises multiple rounds with high preferences, founders may find that even a solid acquisition produces little to no personal return. This becomes especially relevant in:
- Down rounds
- Soft exits (under €50M)
- Highly diluted cap tables
In extreme cases, liquidation preferences stack and leave founders with less than 10% of exit proceeds.
Liquidation Preference Example
Company raises:
Exit at €20M:
- Series A gets €10M first
- Then 20% of remaining €10M (€2M)
- Total to Series A: €12M
- Remainder to Seed and common: €8M
Even though the exit was double the capital raised, the founder gets significantly less than they expected.
Liquidation Preference in 2024–2025
In 2025, liquidation preferences are not only more common—they're also creating real tension among investors. As exits become more complex and valuations fall short of previous highs, venture capitalists are increasingly finding themselves at odds. Structured share classes that once sat quietly on the cap table are now influencing outcomes, with late-stage investors positioned to take most or all of the proceeds in modest exits.
When M&A deals are on the table, each preferred share class may vote differently depending on their place in the liquidation stack. If Series D investors are guaranteed a 1x return, for example, but the exit price is just above their investment amount, they could block earlier-stage investors from receiving anything at all. This forces VCs who typically collaborate to negotiate internally just to get deals over the line.
These tensions are also surfacing in new funding rounds. As late-stage investors demand higher liquidation multiples and pay-to-play provisions, early-stage investors may see their equity heavily diluted or subordinated. According to Micah Rosenbloom of Founder Collective, "Your holdings may be dramatically lower in value than you think, after all this structure comes into play."
Even IPOs introduce complications. While all preferred shares convert to common in a public offering, the outcome may still leave late-stage investors underwater if the IPO price is below their entry valuation—as seen in Instacart's 2023 offering.
In short, liquidation preferences are no longer just legal fine print—they're shaping investor behavior, deal negotiations, and founder outcomes in ways that didn’t matter during bull markets. Founders need to understand not just what preferences are—but how they align or conflict across investor classes when things get messy.Recent data from PitchBook and Carta shows a rise in structured deals—especially in down rounds. Participating preferences and 2x liquidation clauses are becoming more common as investors seek downside protection.
In 2025:
- Many startups are exiting below peak valuations from 2021
- Investors are pushing for more protective terms
- Founders need to model exit outcomes under different preference scenarios
How to Navigate Liquidation Preferences as a Founder
- Negotiate for 1x non-participating—this is market standard and founder-friendly
- Push back on 2x or participating clauses unless the valuation justifies it
- Understand stacking—each round adds a new layer of preferred stock
- Model exit scenarios before signing a term sheet
- Seek caps if participation is required
- Know what you’re trading off—preferences protect investors, but they can also discourage talent and alignment at exit
Liquidation preferences are one of the most critical terms to understand in venture financing. They aren’t inherently bad—they protect early risk capital—but they must be understood and negotiated wisely.
In 2025, as exits become more modest and funding structures shift, founders must understand the real cost of capital—not just the headline valuation. Ask questions. Build models. And don’t just focus on getting the deal—focus on how that deal pays out.
