The Trouble with Liquidity Preferences

Entrepreneurs understandably hate liquidity preferences, that euphemism for a neat trick by which venture investors get paid one, twice, or even three times (or more!) before you get paid at all if you sell your company or take it public. Unbeknownst to most, however, entrepreneurs hate them so much that many times they are negotiated down, or even away, before they snare entrepreneur at an exit.

While that is understandably cold comfort, it is worth reminding yourself. Check this new Berkeley paper on the subject:

…common shareholders have various ways of impeding these preference-triggering transactions, and may use their holdup power to capture part of the VCs’ preferences. Little is known about VCs’ cash flow outcomes: whether VCs receive their full liquidation preferences when startups are sold. Using a hand-collected dataset of VC-backed startups, we find that VCs frequently “carve out” part of their preferences for common shareholders. We also find that the expected value of these carveouts is larger when the common have more holdup power.