Fund Structure
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Quick Answer
The distribution order determining how sale or liquidation proceeds flow to different shareholder classes — senior preferred shareholders are paid before junior preferred, who are paid before common.
The waterfall describes the order in which proceeds from a liquidation event (acquisition, dissolution) are distributed to different stakeholder classes. Each 'tier' in the waterfall must be fully satisfied before proceeds flow to the next tier. Typical waterfall order: Senior secured debt → Junior debt → Series B preferred (latest investors) → Series A preferred → Seed preferred → Common stock (founders, employees). For each preferred class, their liquidation preference is paid first; if non-participating, they then have the option to convert to common and share proportionally. Waterfall modeling — calculating exactly how much each stakeholder receives at different exit prices — is critical for founders evaluating acquisition offers. An offer that seems large on the surface may leave founders and employees with much less than expected after preferred liquidation preferences are satisfied.
In Practice
Consider TechCorp selling for $100M with a complex cap table. First, $20M goes to Series B preferred shareholders (2x liquidation preference). Next, $15M goes to Series A preferred (1.5x preference). The remaining $65M gets distributed pro-rata among all shareholders on an as-converted basis. Common shareholders—including founders and employees—only participate in this final $65M pool, despite the company's $100M exit value.
Why It Matters
Understanding liquidation waterfalls is crucial because they determine your actual payout in an exit, which often differs dramatically from your ownership percentage. Founders frequently focus on dilution percentages while ignoring how liquidation preferences stack up. In down exits or modest wins, the waterfall can mean the difference between meaningful returns and getting wiped out entirely, especially for common shareholders.
VC Beast Take
Most first-time founders completely botch waterfall modeling and get surprised at exit time. The dirty secret? In many 'successful' exits under $100M, founders and employees see minimal payouts due to stacked preferences and participation rights. Smart founders model multiple exit scenarios early and negotiate liquidation terms as aggressively as valuation. The waterfall often matters more than the headline valuation.
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The waterfall describes the order in which proceeds from a liquidation event (acquisition, dissolution) are distributed to different stakeholder classes. Each 'tier' in the waterfall must be fully satisfied before proceeds flow to the next tier.
Understanding Waterfall is critical for founders navigating the fundraising process. It directly impacts deal terms, valuation, and the relationship between founders and investors.
Waterfall falls under the fund-structure category in venture capital. This area covers concepts related to how venture capital funds are organized, managed, and governed.
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