1. Liquidation Preference vs. 2. Antidilution
Liquidation Preference*: The determining term on how the proceeds of an exit will be shared. The preference is given to preferred shareholders before common stockholders and can have vast implications for investors/entrepreneurs. Three types with very basic examples below:
- Fully Participating: Receive shares on an “As-converted” basis i.e. if you have 2x Liquidation preference on 20% stake in a $100M post-money valuation (i.e.a $20M investment). If the firm sells for $240M you will receive $40M (2x preference) and then 20% of remaining $200M or $40M for a total of $80M or 33% Ownership. Founders receive remaining $160M. C:V. Thought: Yikes.
- Capped Participation: Will only participate up until a limit (i.e. 2x cap). In this case, the firm makes more than double their money so they will not participate and simply receive 20% of $240M or $48M. Founders receive remaining $192M. C:V. Thought: Less Yikes.
- Non-Participating: Firm sells for $240M, investors receive 20% or $48M. Founders receive remaining $192M. C:V. Thought: Normal.
*Editor’s Note: we combine participation and preference in this term
Antidilution: A protective measure in the unfortunate case of a down round, it offers investment protection for investors by redefining the ownership of their initial investment. Two types below:
- Full Ratchet: The harshest of the provisions, this translates the equity ownership from the prior round to the new price at the lower round. i.e. If the original round was 20% on $100M Post (i.e. $20M investment) and the new round only valued the company at $50M the investors would then be awarded shares to keep their ownership the same at $20M or 40% of the new company. (See, we weren’t kidding that this was basically draconian…)
- Weighted Average: A more forgiving provision that puts the incentive on both sides of the table. The weighted average model only considers the new shares being issued and not the entire pool.
C:V.’s Chief Term-ologist’s Take: While Antidilution eased into the finals, we feel that they will not have an easy time with Liquidation Preference. The powerhouse in the bracket, the Liquidation Preference can drastically reshape an investment landscape and even Antidilution’s most drastic provisions for down rounds should not be enough to overtake the Preference.
Outcome: Liquidation Preference rolls into the finals with a win over Antidilution.