The liquidation preference reads like a 1x participating preferred statement: "We have the RIGHT to get back our capital AND then everything is split pro rata."
Shouldn't liquidation preference clauses read more like: "We have the OPTION to get back our capital OR ELSE everything is split pro rata."?
Also... can you explain the dividend clause? I understand the preference (preferred dividends get paid first), but what is the significance of 8% (8% of what)?
The liquidation is pro-rata for the common shareholders. So once Preferred gets paid, the common splits the remaining pro-rata. With the actual docs (Shareholders rights agreement that goes with the purchase, it would be clear).
8% of the amount invested. This is a standard term to allow investors to get paid if the company is in business a long time is cash flow positive, but not likely to have a liquidation event. VC funds typically have a 10 year life and need are way to return money to their LPs.
To be clear for those who aren't following the salient detail here - the preferred stock does not convert to common if the liquidation preference is exercised. The investor gets up to their money back (1x preference), and no more.
If they choose to participate pro-rated they convert to common first, and participate equally with everyone, without the preference.
The investor would chose to convert to common when the sale price is greater than the post-money valuation of the deal. On this basis their pro-rated participation will be greater than the amount invested.
If the sale price is less than the post-money valuation of the deal, they would be sensible to keep their preferred stock, and exercise their 1x preference, meaning they get their original amount back 100 cents on the dollar. The remaining is then split between the common shareholders proportionally (in effect without the dilution from the investor that exercised their preference).
Mark Suster (@msuster) from GRP put together a good spreadsheet [1] that shows the preference effect on sale, including preferred non-participating stock and preferred-participating (PP) stock (essentially double dipping into sale proceeds).
Brad Feld (@bfeld) from Foundry Group has a good write up of the different types of participation on his blog [2].
Shouldn't liquidation preference clauses read more like: "We have the OPTION to get back our capital OR ELSE everything is split pro rata."?
Also... can you explain the dividend clause? I understand the preference (preferred dividends get paid first), but what is the significance of 8% (8% of what)?