In venture capital, liquidation is the mechanism that allows investors – such as Limited Partners and VC funds – to realize a return on their investments. Because private company shares cannot be easily sold, a liquidity event is typically required, such as an Initial Public Offering (IPO) or a merger/acquisition (M&A). This creates pressure for startups to achieve a profitable exit within the VC fund’s fixed timeline, usually 7-10 years.
Investors usually hold Preferred Stock, which entitles them to be paid before founders and common shareholders during liquidation. Liquidation preferences ensure that investors recover their capital first. Participating Preferred (the “Double Dip”) allows investors to receive both their initial investment back and then convert their shares to take a pro-rata share of remaining proceeds, potentially leaving founders with little or nothing. Stern illustrates this through examples where aggressive liquidation terms completely consume the sale proceeds, emphasizing the importance for founders to maintain profitability to avoid accepting harsh terms.
