Liquidation Preferences

The liquidation preference is a core feature of start-up investing. The liquidiation preference places preferred stockholders senior to common stockholders in the event of a deemed liquidation event (merger, sale of assets, or dissolution).

With the exception of participating preferred stock, it's worth keeping in mind that series investors do not really want to receive the liquidation preference. The liquidation preference plays a role in providing series investors down-side protection. Series investors looking to maximize their return are hoping that a sale comes at a price that far exceeds the amount of money they might have received via their preference so they can convert to common stock and reap a larger return.

Like other aspects of preferred stock rights, the rights to a liquidation preference in the event of a liquidation event are heavily negotiated contractual provisions. Courts will not presume what parties intended when they negotiated the rights for themselves. Parties represented by sophisticated counsel who had the opportunity to negotiate for certain rights or protect themselves against certain eventualities should not expect the courts to rescue them when the contracts are sought to be enforced against them.

In Alta Berkeley, the parties disagree whether series investors were required to convert their shares to common stock rather than receive their liquidation preference when the company proposed to enter into a merger agreement.