Compare liquidation preferences using proceeds available to shareholders

A proposed sale price is not necessarily the amount distributed among shareholders. Build the transaction's bridge through debt repayment, expenses, adjustments, escrows and other claims before applying equity rights. Ask the transaction advisers which amounts are available now and which remain conditional. Otherwise, a correct ownership calculation can be applied to the wrong proceeds.

This guide compares two deliberately simplified financing terms. It does not value the company or predict an exit. Have counsel interpret the actual charter and related agreements, including the events that trigger the preference and the order among different classes. The waterfall should implement those conclusions rather than supply them.

Cooley GO distinguishes non-participating preferred stock, whose holder receives its preference or the as-converted amount, from participating preferred stock, which can receive a preference and then share in remaining proceeds. It emphasizes that specific preferred rights are negotiated. Caps, multiples and other provisions can change the result.

Assume a hypothetical investor paid $4 million and owns 25% on an as-converted basis. Compare a 1x non-participating preference with a 1x participating preference without a participation cap. There is one preferred class, no accrued dividends and no further issuance. Every proceeds amount below is already available for equity holders after other obligations.

At $8 million of equity proceeds, non-participating preferred receives $4 million because that exceeds 25% of $8 million, or $2 million. Common holders receive $4 million. Participating preferred receives its $4 million preference plus 25% of the remaining $4 million, totaling $5 million. Common holders receive $3 million.

At $20 million of equity proceeds, non-participating preferred takes its $5 million as-converted amount, leaving $15 million for common. Participating preferred receives $4 million plus 25% of the remaining $16 million, totaling $8 million, with $12 million for common. Equal investment and ownership therefore produce different distributions under the two assumed contracts.

At only $2 million of proceeds, the investor receives the available $2 million under either assumed preference. A 1x term does not create money that the company lacks. Never subtract the full $4 million preference and allocate a negative remainder to common holders.

The non-participating investor's $4 million preference equals its 25% as-converted payout at $16 million of proceeds. That switching point helps check the model. It changes if the investment, multiple, ownership or other rights change. With several preferred classes, conversion choices and seniority can require a more complete model.

Ask about participation caps, accrued dividends, transaction-specific payouts and distributions over time. Identify whether escrow releases follow the original allocation or another provision. Do not apply the simple table to a more complex capitalization merely because the term sheet also uses the words 1x preference.

Compare term sheets across a range of proceeds that management can explain, including an outcome below invested capital. Show each class's cash and verify that distributions add to the available amount in every case. Keep tax consequences outside the table until the appropriate adviser supplies them.

Review the preference together with the cash raised, ownership and other negotiated rights. A higher headline valuation does not settle the distribution question. Retain the counsel-reviewed waterfall with the chosen terms so management understands the economic arrangement it approved before a future transaction makes the allocation consequential.