Venture Capital Jobs & Tips To Break Into VC - 06

Hi👋 VC Crafters, Welcome to today’s VC Crafters’s - Weekly Break Into VC Newsletter - To Get Tactical Advice To Learn, Implement & Craft Path To Venture Capital.

Today At A Glance:

Are you looking to break into VC ? Want access to the Job Board & 5000+ investors contact database, Want to join weekly events by VC Professionals / founders & Want to deep dive into VC World Ocean?… No Worry,

→ Join our 100+ VC enthusiast community to learn, network and craft your path to venture capital with our resources and networking sessions!

Today’s Deep Dive

WHAT'S THE LIQUIDATION PREFERENCE IN THE TERM SHEET? WITH EXAMPLE

A term sheet is a non-binding legal agreement (non-disclosure and non-sharing) between the founders & investors that shows the investor’s interest in that startup.

Understanding clauses like 1x liquidation participation or non-participation is crucial for both investors and founders in order to protect and maintain the value of their investments during a liquidation event. It is essential for founders to grasp these concepts and make informed decisions about whether a 1X or 2X liquidation preference is the right choice for their circumstances.

Let’s understand this with a simple example:

Consider a startup that got the term sheets from PQR Fund including the investment aspects as follows:

• $ Invested: $4M

• Pre-Money Valuation: $8M

• Post-Money Valuation: $12M

• Employee Stock Option Pool: 15%

• Liquidation Preference: Let’s take two cases:

  • Case I: 1X Non- Participating Liquidation

  • Case II: 1X Participating Liquidation

I hope you are aware of the terms like Pre-money, Post money valuation or option pool. If not then I must say to read our previous writeup on this - Link

If you see the last row, you will find that term called Liquidation Preference. So let’s understand this term first.

Liquidation Preference:

It is the priority that investors have in receiving proceeds (money) from the sale or liquidation of a company. In layman's terms, it means that the investors with a liquidation preference have the first right to get their money back before any proceeds are distributed to other shareholders.

For example,

if an investor has a liquidation preference of 1x, they would get their initial investment back before any proceeds are distributed to other shareholders. If the investor has a liquidation preference of 2x, they would get twice their initial investment before any proceeds are distributed to other shareholders. Here In this term sheet, you can see VC fund PQR have 1X liquidation preference. It means in case of liquidation of the company, funds PQR first received the initial invested amount back before any proceeds are distributed to other shareholders.

There are two other terms also involved in it - participation and non-participation liquidation preference. Let’s understand both the terms, participation, and non-participation liquidation preference.

Non-Participation Liquidation Preference:

Upon liquidation, non-participating investors have the choice of receiving their funds in one of two ways: either based on a 1X preference or according to their stake in the company. Investors typically compare the potential returns from each option and select the one that would provide the most benefit for them.

Ex - Suppose for fund PQR - if in liquidation (sale) of a company valued at $10 M. let’s calculate the return for investors from both ways:

1. 1X liquidation means investors get 1X of the investment amount - so $4M OR

2. Based on the percentage of stake - 33% * $10M (Valuation) - $3.3M.

So after calculation, it’s clear that option 1 - 1X liquidation preference gives more return to the investor hence he will choose the 1X option and get a return of $4M. And the rest amount of $6M ($10M - $4M) will distribute to other shareholders.

Participation Liquidation Preference:

During the liquidation of a company, investors with a participation liquidation preference are entitled to receive their funds through both methods - a 1X preference and a percentage of their stake in the company.

Ex -

Let’s take the same example as above if the fund PQR took the 1X participation liquidation preference then the calculation would be the same - but investors will get a return from both ways so 1X liquidation preference = $4M and Based on percentage stake = $3.3M. So total return for the investor = $4M + $3.3M = $7.3M and the rest amount of $2.7 ($10M - $7M) will be distributed to another stakeholder.

As a founder, if your company is liquidated and there is a participation liquidation preference in place, your returns will be minimal. Therefore, it's advantageous to have a 1X non-participation liquidation preference in the term sheet. Additionally, most venture funds typically use a 1X non-participation liquidation preference as it aligns the interests of investors and other stakeholders in the event of company liquidation.

I hope this write-up will help you to understand these clauses.

If you want to learn more about the term sheet, must recommend reading our previous writeups on the term sheet - here

Join 1000+ VC Enthusiast to get tactical advice to build your career in VC….

Today’s Venture Capital Jobs & Internship

• VC Analyst - Fundamental VC | Germany - Apply Here

• Part-time startup/VC researcher - Julian Capital - Apply Here

• Investment Analyst - Giga Venture | UK - Apply Here

• Senior Associate – Investments - Six Sense Venture | India - Apply Here

• VC Investor @ GIGA London, New India team | India - Apply Here

• Marketing Manager - MicroVentures | USA - Apply Here

• BD Associate - Tech starts | USA - Apply Here

• Investor Relations Analyst - Qualgro Partners  | Singapore - Apply Here

• Student Assistant - Smart Infrastructure Ventures ('SIVentures') | Germany - Apply Here

Want daily VC job Updates, join our community - VC Crafters

→ Get Access to Curated VC CV/Resume Template - Download Here.

Weekends Reading On Venture Capital

• Understanding Churn and Building an Action Plan to Fix the proverbial “Leaky Bucket” By Bessemer Venture Partner Read Here (Startups)

• Hydrogen had a breakout year. Why are some VCs still sceptical? Read Here (Venture Capital)

• The VC's Customer By AVC Read Here (Venture Capital)

• LPs Doubt Venture Funds’ Startup Valuations Read Here (Venture Capital)

Want to break into VC? Confused about where to start and how to access opportunities?

Join our 100+ VC Enthusiast Community - VC Crafters To Learn, Network, Collaborate & Craft Path To Venture Capital.