5/20/2021 Tip: Liquidation Preference

Today’s Quote

“No institution can possibly survive if it needs geniuses or supermen to manage it. It must be organized in such a way as to be able to get along under a leadership composed of average human beings.”
~ Peter Drucker

 

Today’s Tip

I get the same question a lot from entrepreneurs raising equity capital (venture capital or angel funding).

The question is whether they need to issue common or preferred stock.

The answer depends on how and what rights are defined in the preferred stock.  One very popular “preferred right” or “preference” that adds very significant value to outside investors and is common in venture capital investments is a liquidation preference.

The liquidation preference means what it sounds – namely that preferred stockholders with this right get all of their money back (i.e. liquidate their shares) before any distribution of proceeds in the event of a sale of a company.  This is an extremely valuable preference that can best be shown by example.

Let’s say an investor buys 1,000,000 shares of stock in a company at $5/share and the company’s total shares outstanding is 3,000,000 shares (implying a pre-money valuation of $10 million (2 million shares @ $5/share) and a post-money valuation of $15,000,000 (3 million shares @ $5/share)).

If, then the company were to be sold for $5,000,000 (i.e. at 1/3 of its original post-money valuation), then if the investor owned common shares (or preferred shares without the liquidation preference), then they would receive back $1,666,666 of their original $5,000,000 investment.

If, on the other hand, they owned shares WITH this liquidation preference, they would then receive their ENTIRE $5,000,000 original investment back. This is obviously a big, big difference to both the entrepreneur and the investor.

So make sure if an investor is offering you funding that you understand the type of stock they want to purchase and the specific rights (such as liquidation preference) that they seek, and negotiate accordingly.

 

Today’s Resource

Forget Old School!

The “old-school” way of raising venture capital is DEAD! 

And that’s why I created this page for you… to show you how to do it right.

See the right way to raise venture capital <– 

There’s a common mistake almost every entrepreneur makes… and if you approach venture capitalists like most entrepreneurs, you’ll NEVER get funded. 

Here’s how to do it right <—

 

Trivia

Today’s Question: What product that makes unpacking fun was invented by sealing two shower curtains together by two engineers who intended to use it as wallpaper?

Previous Question:  What product that was marketed by Suzanne Somers was invented by a former Buddhist Monk?

Answer: The Thigh Master was invented by a man who was once a Buddhist Monk. Since its invention, the Thigh Master has netted over $100 million in sales worldwide. It is one of the most recognizable home fitness products of the last two decades. 

An innovative sales campaign, and affordable price, and a well-known celebrity helped propel sales beyond the $100 million dollar mark. 

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