Liquidation preference: key element in investment agreements

Liquidation preference is a clause in the investment terms that specifies how the proceeds will be distributed among shareholders in the event of a liquidation, sale or other exit scenario. This preference gives investors, typically venture capitalists, the right to recover a certain amount of their invested capital before other shareholders such as the founders or employees with stock options. The introduction of a liquidation preference serves to mitigate the risk for investors and ensure that they have a prioritised claim to a portion of the proceeds in an exit event, making the decision to invest in high-risk companies more attractive.