What is a liquidation preference?

A 1x preference returns the amount invested; higher multiples return more. With a non-participating preference, investors choose between their money back and converting to common shares, while a participating preference pays both. Later rounds may rank ahead of earlier ones, which matters most when a sale price falls short.

Say investors put $10 million into a startup with a 1x preference and it sells for $10 million. They take all of it, and the founders get nothing.

It protects investors in a modest sale, and it can leave founders and employees with little even when a company sells for a large sum.