Liquidation Preference

One of the mechanisms employed to hedge investment risks in a private equity transaction is that of a liquidation preference. Extensive time is spent on structuring the liquidation preference while negotiating such investments. The meaning of a liquidation preference right is that when a "liquidation event" is triggered, the investor is entitled to receive an amount equal to or a multiple of its investment in preference over other shareholders. Such multiple could be double or more of the amount of the original investment. Waterfall provisions in an investment agreement provide for, the sequence in which different classes of shares have a preference. For example, Series A shareholders may be entitled to 3x their investment at liquidation and the holders of Series A shares shall have a first claim over the Series B shares, whose holders are entitled to 2x of their investment amount at liquidation.