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Dead zone

The band of exit values across which the common shareholders receive nothing extra, however much the price rises.

What it means

The dead zone is the range of sale prices over which founders and employees hold shares that are worth nothing, because every additional pound or euro of proceeds goes to satisfying liquidation preferences before it reaches the common. It begins at zero and ends at the point where the preference stack has been fully paid. Where preferences are participating, or where a stack has grown across several rounds, the zone can extend well past what most people would consider a successful outcome.

Why it matters

It changes which offers are worth pursuing. Inside the dead zone an extra EUR 2m on the sale price is worth exactly nothing to the team, so an acquisition at EUR 5m and one at EUR 7m are financially identical to everyone holding common. Knowing where the zone ends tells a founder what the smallest genuinely good outcome looks like, and it tells an employee what their options are actually worth. It is also the number that explains why a founder might reasonably decline an offer that looks respectable from the outside.

Worked example

A company has raised EUR 6m across two rounds, all 1x non-participating, against 10,000,000 shares of which the founders and employees hold 6,000,000. Sell for EUR 4m and the preferences take all of it, so the common gets nothing. Sell for EUR 6m and the preferences take all of it again, so the common still gets nothing. The dead zone is therefore everything up to EUR 6m. Just above it the common begins to participate but thinly: at EUR 8m the EUR 2m above the stack is split across the common, so 6,000,000 founder and employee shares share EUR 1.2m, which is EUR 0.20 a share. Make the same EUR 6m participating rather than non-participating and the zone does not end at EUR 6m at all: the preferred takes its money back and then a share of everything above it, so the common climbs out far more slowly and an EUR 8m sale pays them less than the EUR 0.20 a share above.

The common mistake

Valuing an option grant against the headline valuation of the last round. An employee told their 50,000 options are worth EUR 250,000 because the company was valued at EUR 50m is being quoted a number that ignores the preference stack entirely, and on a EUR 12m sale of that same company they may be worth nothing at all. The second mistake is founders modelling only the optimistic exit, which is the one case where the dead zone never comes up.

In practice

Every priced round makes the zone wider by the amount raised, and a round with participating preferred or a preference multiple above 1x widens it by more than the cash. It is worth recalculating after each round and telling the team honestly what it means for their options, because the alternative is people discovering it at the sale. The exit waterfall tool reports the ceiling directly. It is also the number to have ready when an acquirer makes a first approach, because the answer to whether an offer is worth exploring is arithmetic rather than judgement, and a founder who has to go and work it out has already lost a week.

What to ask

Ask what the total liquidation preference is, then ask what the company would have to sell for before your shares are worth anything. The second question is the one that matters and most people never ask it, partly because it sounds pessimistic and partly because it is genuinely awkward. Ask it anyway, and ask it again after every round, because each one moves the answer. If you are a founder, work the figure out before the round rather than after, and tell your team honestly what it means for their options: an employee who discovers the dead zone at the sale will conclude they were misled, and they will have a point. Recalculate it after every round and tell the team the new figure, because an option grant is only as honest as the number the holder is given alongside it.

Model thisExit waterfall

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