Liquidation Preference

DEFINITION of 'Liquidation Preference'

A term used in venture capital contracts to specify which investors get paid first and how much they get paid in the event of a liquidation event such as the sale of the company. Liquidation preference helps protect venture capitalists from losing money by making sure they get their initial investments back before other parties. If the company is sold at a profit, liquidation preference can also help them be first in line to claim part of the profits. Venture capitalists are usually repaid before holders of common stock and before the company's original owners and employees.

BREAKING DOWN 'Liquidation Preference'

More generally, liquidation preference can also refer to the repayment of creditors (such as bondholders) before shareholders if a company goes under. The company will sell its assets, then use that money to repay senior creditors first, then junior creditors, then shareholders. Though creditors have a better chance of being repaid in the event of a liquidation, their lower risk comes with a lower reward. Creditors generally earn interest on their loans at a lower rate than the returns shareholders receive on their investments.



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