Deal Terms
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Quick Answer
Any transaction that triggers distribution of proceeds to shareholders — including company sale, merger, or dissolution.
A liquidation event is any transaction or circumstance that triggers the distribution of company value to shareholders according to the liquidation waterfall. Common liquidation events: sale or merger of the company (most common), an IPO (sometimes defined as a liquidation event in early term sheets, but often carved out), or actual dissolution and wind-down of the company. Liquidation events trigger preferred stock liquidation preferences — investors receive their preferences before common shareholders receive anything. The definition of 'liquidation event' in a company's charter is critically important: if an IPO is defined as one, investors can choose between their liquidation preference and converting to common stock; if it's not, all preferred automatically converts at IPO.
In Practice
TechCorp Inc. is acquired by MegaCorp for $100M cash. The liquidation waterfall distributes proceeds as follows: First, $5M in liquidation preferences go to Series A investors who invested $5M. The remaining $95M is distributed pro-rata among all shareholders based on their fully-diluted ownership. Founders with 60% ownership receive $57M, employees with 20% get $19M, and VCs with 20% receive $19M plus their initial $5M preference, totaling $24M. Had TechCorp been sold for only $3M (below the liquidation preference), Series A investors would receive the entire $3M, leaving nothing for common shareholders.
Why It Matters
Understanding liquidation events is crucial because they determine how much money each stakeholder receives when the company exits. The liquidation waterfall can dramatically impact founder and employee payouts, especially in lower-value exits. Liquidation preferences, participation rights, and seniority structures all affect the final distribution. Founders who don't understand these mechanics may be surprised to learn they receive little or nothing in certain exit scenarios, even if they own a significant percentage of the company on paper.
VC Beast Take
Most founders focus obsessively on valuation and dilution but completely ignore liquidation terms until it's too late. We've seen deals where founders owned 40% of the company but walked away with less than 5% of the exit proceeds due to stacked liquidation preferences and participating preferred structures. The liquidation waterfall is where the real money gets allocated — everything else is just paperwork. Smart founders model different exit scenarios before signing term sheets.
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A liquidation event is any transaction or circumstance that triggers the distribution of company value to shareholders according to the liquidation waterfall.
Understanding Liquidation Event is critical for founders navigating the fundraising process. It directly impacts deal terms, valuation, and the relationship between founders and investors.
Liquidation Event falls under the deal-terms category in venture capital. This area covers concepts related to the financial and legal terms that define investment agreements.
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