Liquidating value of preferred stock
This necessitates creating complex spreadsheets to model what happens upon a sale of company at different transaction values.
The most sophisticated spreadsheets will also take into account whether options and warrants are in the money at certain transaction values, which will affect whether or not they are exercised, which will then affect the price per share.
First I want to touch on a couple of other key economic terms you should understand: Dividends often get overlooked.
Many venture financing rounds will include dividends that continue to accrue and get paid in the event of a liquidation (i.e. In other words, your investors’ liquidation preference grows by X% every year.
Participating preferred stock is favored by investors because they will receive a preferential return over both low and high exit transaction values.
Which brings me to: Liquidation preference means that investors get their money back first. the investor gets his/her initial investment back before the holders of common stock receive anything).
As mentioned above, accrued dividends are typically treated as part of the liquidation preference and paid before common shareholders receive anything.
So the common shareholders own 66.6% of the company on a fully-diluted basis and the Series A investors own 33.3%. Everyone is on equal footing and the proceeds are split up evenly based on percentage ownership.
Assume the preferred shareholders have a 1X liquidation preference. In this case, when the company is sold the investors get 33.3% (M/M) and the Founders get 66.6%. The x-axis represents the total liquidation value of the company.
In other words, the investor will take his/her liquidation preference until: Fully Diluted Ownership % * Total Liquidation Value In the case of Participating Preferred Stock, there is no choice. The investor receives her liquidation preference then shares the remaining proceeds as if her stock had converted to common.