Liquidation preference

A liquidation preference is a clause in a preference share agreement that determines the order and amount in which investors are repaid when a company is sold, merged, or wound up. It protects investors from losing money in a modest exit even if common shareholders receive nothing.

How it works: An investor with a 1× non-participating liquidation preference on a ₹1 crore investment gets their ₹1 crore back first before any proceeds reach founders or employees. If the company sells for less than ₹1 crore, the investor takes everything. If it sells for more, the investor takes ₹1 crore and the remainder flows to common shareholders.

Participating vs. non-participating: Non-participating preference (the more founder-friendly form) means the investor either takes their preference OR converts to common shares and participates pro-rata — whichever is greater. Participating preference (often called 'double-dipping') means the investor takes their preference return AND then also participates pro-rata in the remaining proceeds alongside common shareholders. Participating preference significantly reduces founder payouts in medium-sized exits.

The multiplier: Most Indian VC term sheets carry a 1× preference, meaning investors get their invested capital back. Some distressed or late-stage deals carry 1.5× or 2× — meaning investors get 1.5× or 2× their investment back before common shareholders see a rupee. Higher multiples make smaller exits almost entirely investor-captured.

Why founders must understand it: In an acquisition scenario, the liquidation waterfall determines what founders and employees actually receive. A ₹50 crore acquisition sounds excellent until a 2× participating preference on ₹30 crore of raised capital consumes most of the proceeds.