When a company gets acquired or sold, the waterfall determines who gets paid what and in what order. Think of it as a strict pecking order for dividing up the proceeds.
Say a company sells for $50 million after raising $15 million total. The Series A investor put in $10 million with a 1x liquidation preference and non-participating rights. The Series B investor put in $5 million with a 1x liquidation preference and participating rights.
Here’s how the money gets split:
First: Liquidation Preferences Investors get their protected amounts right off the top. Series A takes their $10 million, Series B takes their $5 million. That leaves $35 million on the table.
Next: Participation (the “double dip”) Since Series B has participating rights, they get to come back for seconds. If they own 10% of the company, they grab another $3.5 million (10% of that remaining $35 million). Now we’re down to $31.5 million left.
Finally: Common Stock Only after investors get everything they’re entitled to does the rest go to founders and employees with common stock. In this case, that’s $31.5 million.
This is why founders can walk away with little or nothing even from a seemingly good exit. If this company had sold for just $15 million, investors would’ve taken the entire amount in that first tier, leaving founders with zero.
The term “waterfall” also comes up in venture fund economics, where it governs how profits get split between the Limited Partners (the investors in the fund) and the General Partners (the fund managers). The typical structure works like this:
