Exit planning
Liquidation preferences and exit proceeds
See why ownership percentages differ from exit proceeds, with examples of a 1x nonparticipating preference and participating preferred stock.
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Ownership and payment rights are separate
A liquidation preference gives a class of stock a payment priority over another class in a covered liquidation event. Cooley’s liquidation preference definition explains this ordering. The applicable company and transaction documents determine which events trigger the right.
An ownership percentage describes a share-count ratio. An exit waterfall applies payment rights to the proceeds available for distribution. The two can produce different percentages for the same holder.
A 1x nonparticipating example
Assume an investor put in $2,000,000 for preferred shares representing 20% on an as-converted basis. The remaining 80% is common stock. Give the preferred a 1x nonparticipating preference and a choice to convert. Exclude debt, other preferred classes, dividends, awards, fees, tax, and escrow.
Under these assumed terms, compare the $2,000,000 preference with the amount obtained by converting and taking 20% of proceeds. The holder takes one alternative, not both.
| Sale proceeds | 20% as converted | Investor receives | Common receives |
|---|---|---|---|
| $5,000,000 | $1,000,000 | $2,000,000 | $3,000,000 |
| $10,000,000 | $2,000,000 | $2,000,000 | $8,000,000 |
| $20,000,000 | $4,000,000 | $4,000,000 | $16,000,000 |
The alternatives meet at $2,000,000 ÷ 20% = $10,000,000. At the $5,000,000 sale, 20% ownership yields 40% of the proceeds because of the preference.
Change the participation terms
Now change only the example’s rights: assume the investor receives its $2,000,000 preference and then participates in the remainder at 20%, with no participation cap. At a $5,000,000 sale, the remainder is $3,000,000. The investor receives $2,000,000 + 20% × $3,000,000 = $2,600,000, and common receives $2,400,000.
This is an illustration of explicitly assumed participation rights. A participation cap, a different multiple, another senior class, or a different conversion rule would require a different calculation.
Account for shortfalls and other claims
A preference is a claim on proceeds, not a guarantee that enough money exists to pay it. In the simplified nonparticipating example, a $1,000,000 distribution cannot pay a $2,000,000 preference in full. Adding creditors or senior classes can further change the amount available to a particular holder.
To use cap table software for exit planning, record the relevant rights and inspect both claims and actual modeled payments. In Cap Table’s exit waterfall, compare several sale values, review the award assumptions, and inspect the breakeven points. The model excludes escrow, fees, and tax, so it does not calculate an individual’s final net payment.