All You Need to Know About Pari Passu Liquidation Preference

If you're a startup founder, then you've probably heard of the term "pari passu liquidation preference." But what exactly is it?

And how can you make sure that your company gets the best possible terms when negotiating with investors?

What Is a Pari Passu Liquidation Preference?

When it comes to startup investing, there are a lot of different terms that get thrown around. One of those terms is “Pari passu liquidation preference. ” So, what is a pari passu liquidation preference?

In short, a pari passu liquidation preference is a type of investment structure that gives investors the right to be paid back before common shareholders if the company is sold or goes public.

To understand why this is important, let’s take a step back and look at the different types of shareholders in a company.

There are two main types of shareholders:

Common shareholders and preferred shareholders.

Common shareholders are the “regular” shareholders.

They own the company’s stock and have a claim to the company’s assets and earnings. However, they also have the least amount of rights and are last in the preference stack (pecking order) to get liquidation preference payouts if the company is sold or goes public.

Preferred shareholders, on the other hand, have a few different rights and protections that common shareholders don’t have.

For example, 1x liquidation preference shareholders are first in the preference stack and have the right to be paid back liquidation preference payouts before common shareholders if the company is sold or goes public.

Now, there are different types of preferred shareholders, and each type has different rights. One type of preferred shareholder is a pari passu liquidation preference shareholder.

Pari passu liquidation preference shareholders have the right to be paid back their investment, plus any accrued interest, before common shareholders receive any money.

However, if there is not enough money to pay back all of the shareholders, then the pari passu liquidation preference shareholders and the common shareholders will share the money equally.

So, why do investors want a pari passu liquidation preference?

Well, it provides them with a bit of extra protection in case the company is sold or goes public. If the company is sold for less than the original purchase price shares, they will still get their money back before the common shareholders.

And, if the company goes public, the pari passu liquidation preference shareholders will still get paid liquidation proceeds before the common shareholders, even if the common shareholders’ shares are worth more.

Overall, the pari passu liquidation preference is a way to protect investors’ money in case the company is sold or goes public.

And it’s a way to make sure that investors get paid back before the common shareholders.

How Do Investors Benefit From a Liquidation Preference?

As an investor, you always want to get the most bang for your buck. A liquidation preference allows you to do just that.

When a company is sold or goes public, the assets are liquidated, and the proceeds are distributed to the shareholders. With a liquidation preference, shareholders get paid first and receive their initial investment back before anyone else gets a dime.

What's even better is a pari passu liquidation preference. This means that if the company is sold, each shareholder receives an equal share of the proceeds, no matter when they are invested.

It could mean the difference between getting paid and getting shafted.

Which Type of Liquidation Preference Is Best for My Company?

When it comes to the liquidation preference, there are a few different types that companies can choose from.

So, which one is best for your company?

It honestly depends on your situation and what you hope to achieve from your investment.

Here's a quick overview of the different types of liquidation preferences and their key features to help you make the best decision for your business:

1. Straight Preferential

This type of liquidation preference gives preference to the initial investors in the event of a sale or liquidation of the company. They will receive their investment back first, before any other shareholders.

2. Pari Passu

Pari passu means "equal footing" in Latin. This type of liquidation preference gives all shareholders, regardless of when they invested, equal rights in the event of a sale or liquidation.

3. Redeemable

A redeemable preference gives the investor the right to redeem their shares for cash or other assets at a predetermined price. This can be helpful if the company is sold for less than the investor's original investment.

4. Cumulative

A cumulative preference means that if the company is sold and the proceeds don't cover the investor's original investment, the investor is still owed that amount plus any accrued but unpaid dividends.

5. Non-Participating

A non-participating preference means that the investor does not have the right to share in the company's profits. This can be helpful if the company is sold for a high price and the investor wants to minimize their taxes.

6. Convertible

A convertible preference gives investors the right to convert their shares into common stock at a predetermined price. This can be helpful if the company's stock price increases after the investment are made.

No matter which type of liquidation preference you choose, make sure you understand the terms and conditions before making any decisions. And, as always, consult with a financial advisor to ensure that you're making the best decision for your company.

How Can I Negotiate a Better Liquidation Preference for My Startup?

It's no secret that startup investors want to protect their investments. One way they do this is by negotiating a liquidation preference that gives them preferential treatment if the company is sold or goes public.

This means that if there's not enough money to repay all investors when the company is sold, the investors with a liquidation preference get paid first.

So, how can you negotiate a better liquidation preference for your startup?

Here are five tips:

1. Understand the different types of liquidation preferences.
2. Know what you're negotiating for
3. Be prepared to give up something in return.
4. Get it in writing
5. Understand the different types of liquidation preferences.

1. Understand the Different Types of Liquidation Preferences

As we mentioned, there are different types of liquidation preferences. In addition to the pari passu liquidation preference, there's also the senior liquidation preference and the multiple liquidation preference.

The senior liquidation preference gives investors the right to be paid before other shareholders, even if they don't have a liquidation preference.

The multiple liquidation preference gives investors the right to be paid a multiple of their investment if the company is sold.

2. Know What You're Negotiating For

Before you start negotiating, it's important to know what you want.

Do you want a pari passu liquidation preference?

A senior liquidation preference?

A multiple liquidation preference?

It's also important to know what kind of liquidation event you're negotiating for.

Is it a sale of the company?

An initial public offering (IPO)?

3. Be Prepared to Give Up Something in Return

Investors aren't going to give up their liquidation preference without getting something in return.

So, what are you willing to give up?

One thing you could give up is a higher percentage of ownership in the company. If you're giving up a larger percentage of the company, you'll need to make sure that the other shareholders are okay with it.

4. Get It In Writing

Once you've negotiated the terms of the liquidation preference, it's important to get it in writing. This way, there's no confusion about what was agreed upon.

The bottom line. A liquidation preference is an investor's right to receive their investment back before other shareholders if the company is sold.

If you're looking to negotiate a better liquidation preference for your startup, it's important to understand the different types of liquidation preferences and know what you're negotiating for.

Be prepared to give up something in return, and make sure to get the agreement in writing.

FAQs in Relation to Pari Passu Liquidation Preference

What is pari passu liquidation preference?

Pari passu liquidation preference is a type of liquidation preference that gives each investor an equal claim to the assets of the company in the event of a liquidation.

How does liquidation preference work?

Pari passu liquidation preference means that investors receive their money back in proportion to their ownership stake in the event of a liquidation. So, if an investor owns 10% of a company, they would be entitled to 10% of the liquidated assets.

Conclusion

A Pari Passu Liquidation Preference is a term that's often used in venture capital (VC) contracts. It means that all investors will be repaid on an equal basis. This type of liquidation preference is generally more favorable to startups since it gives them more control over their own destiny.

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