An increasingly common way of articulating 1x straight liquidation preference (LP) clauses in agreements related to early-stage venture deals is some variation of the following language – “The investor shall be entitled to receive, prior to and in preference to any distribution of the proceeds of the Liquidity Event to any other Shareholders, the higher of (a) an amount equal to 1X of the amounts invested by the investor; and (b) the investor’s pro rata entitlement on an as if converted basis“. This article argues that the above construct adds complexities in the later rounds and also has the potential to prejudice the interests of the very investors it seeks to protect.
This article is divided into three main sections- the first section gives a brief introduction to the concept of liquidation preference in general, and 1x straight liquidation preference in particular. The second section considers a couple of simple scenarios to illustrate how 1x straight liquidation preference (should) work in those scenarios. The third section discusses the legal language under consideration and provides a hypothetical scenario to illustrate one potential pitfall of applying such language literally. Based on these discussions, the conclusion as mentioned above in the introductory paragraph is drawn.
Please click here to read the full article by Lalu John Philip, published in Modaq.
