In the SmartUp methodology, the liquidation waterfall exposes the real economics behind exits. Yonatan Stern explains that payouts follow a strict hierarchy, usually determined by the timing and power of investors. Later-stage investors often dictate terms because the company is desperate for capital. As Stern puts it: “You want my money, I’m first.” This creates a “last in, first out” structure where Series C investors are paid before Series B, who are paid before Series A, and founders and employees sit at the bottom.
A critical component of the waterfall is Participating Preferred stock. This structure allows investors to “double dip.” First, they receive their liquidation preference, meaning they take their invested capital off the top. Then, they convert to common stock and participate again in the remaining proceeds according to their ownership percentage. Investors justify this by citing the high risk they take, and founders often accept these terms under pressure, hoping for a large exit where the impact is minimized.
The lectures illustrate this with the case of a founder named “Joe,” who sells his company for $25 million after raising $31 million across Seed, Round A, Round B, and a down round Series C with Participating Preferred terms. In the payout, the Round C investor takes $10 million off the top. The remaining $15 million is distributed, but due to stacked liquidation preferences, investors absorb nearly all the proceeds. Despite a press release announcing a $25 million acquisition, Joe receives $0.
SmartUp uses the waterfall to warn that headline exits can mask financial failure for founders. Unless an exit significantly exceeds the total capital raised, liquidation preferences can consume the entire payout before it ever reaches Common Stock holders.
