Emerging companies partner Chris Grew authored an article entitled, “The Essential Guide to Liquidation Preferences,” which discusses the options for venture capital investors in a company's trade sale or liquidation. An excerpt from the article is included below.
A liquidation preference gives the VC investor a "first right" to any proceeds available to shareholders in the event of a liquidation or trade sale of the company. Although a liquidation preference provides the VC investor with downside protection by giving them the first money out of the company that is paid to shareholders, it can also significantly increase the upside to an investment.
A non-participating liquidation preference means the preferred shareholders can get their investment back upon a trade sale or liquidation of the company, with the balance of the proceeds going to the holders of ordinary shares. If the ordinary shareholders would get more per share than the preferred shareholders under this approach, the preferred shareholders can voluntarily convert their preference shares into ordinary shares and share pro rata in the proceeds.
Most VC investments include a participating liquidation preference that permits the VC to receive their money back first in a trade sale or liquidation of the company, with the balance of the proceeds being divided amongst the holders of ordinary shares and preferred shares on a share-for-share basis. The participating preference is often referred to as a "double dip" because the VC investor receives their money back and then gets a share of the remaining proceeds.