![]() The danger is that some investors will include a 2x liquidation preference - or even larger - in the contract. It would be too easy for investors to lose money if they didn't include a basic 1x liquidation preference in the contract. You can't argue that it's unfair either as your company's investors have to protect their initial investment. That's an example of a 1x liquidation preference and it's a common practice. ![]() The company's common stockholders would split the remaining money. ![]() With preferred stock options, the investor will receive their original investment of $30 million first and then 30 percent of what remains, which means that they would receive a total of $51 million. If they received common stock in the company, it means that if the company sells for $60 million, they would take a loss since 30 percent is only $18 million. For example, say an investor puts up $30 million for a startup that's been evaluated at $100 million in return for 30 percent of the company. Preferred stocks allow investors to protect their investment in the event that the proceeds of the liquidation ends up being less than the original investment since the proceeds will be given to the holders of the preferred stock first before they are dispersed to other shareholders. Preferred stock is worth more than common stock for a simple reason - preferred stock holders are given preferential treatment if the business is liquidated (such as through the dissolution of the business, sale of the business or through bankruptcy). Almost every investor will insist on preferred stock, with very few exemptions. There are two types of stock that venture capital investors can ask for - p referred stock and common stock. There are investors out there who will include liquidation preferences in the contract that are extremely beneficial to them - and extremely detrimental to the startup's founders. The mistake many startup owners make is not paying attention to the contract's liquidation preferences. It's hard not to be - after all, it probably feels like all of their hard work has paid off. Many entrepreneurs are over the moon when they receive a high valuation and an influx of money. There's a real danger when it comes to accepting investments in your startup if you're not careful.
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