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Preferred stock has a liquidation preference, which can be non-participating or participating:

  • Non-participating liquidation preference: In a sale or liquidation of a company, a preferred stock investor with a non-participating liquidation preference is entitled only to receive up to the liquidation preference amount and does not share in any payment of proceeds to the common stockholders.
  • Participating liquidation preference: In a sale or liquidation of a company, a preferred stock investor with a participating liquidation preference is entitled not only to receive up to the liquidation preference amount but also to share proportionally (based on the number of shares of preferred stock the investor holds) in any payment of proceeds to the common stockholders. The result of this type of liquidation preference is commonly referred to as “double-dipping.”
  • Capped participating liquidation preference: A preferred stock investor with a capped participating liquidation preference is entitled to receive up to the liquidation preference amount and to share in any payment of proceeds to the common stockholders, up to a pre-agreed cap, typically set at a multiple of the investor’s original investment amount.

The type of participation influences whether investors will convert their preferred stock into common stock upon a sale or liquidation of a company. With a participating liquidation preference, investors have no incentive to convert their preferred stock into common stock because they will always be entitled to more proceeds than the common stockholders (i.e., the preference amount plus a portion of what the common stockholders are receiving). With non-participating and capped participating liquidation preferences, however, investors will convert their preferred stock into common stock in the event that the payment the investors would receive as holders of common stock exceeds their preferred stock’s preference amount or the cap, as applicable.

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