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Exit waterfall

When a company is sold, some investors are paid before anyone else. Put in what they invested and on what terms, then move the sale price to see how much actually reaches founders and employees.

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Exit waterfall

Investors usually negotiate the right to get their money back before anyone else is paid. That right is a liquidation preference, and it is why a percentage on a cap table is not a percentage of the sale price. Some investors must then choose: take that guaranteed money back, or give it up and take their percentage instead, whichever is worth more. Others have negotiated the right to do both, taking their money back first and then a share of what is left.

Your percentage tells you nothing about your outcome until you know what sits ahead of it. Owning 40% of a company that sells for €30m is worth nothing if €30m of preference is paid first, and that is the situation this tool is for.

Worked example

You hold 8,000,000 shares, with a 1,000,000 share option pool beside you. An investor put in €4m for 2,000,000 shares on a 1× non-participating preference, so they hold 2,000,000 of 11,000,000, which is 18.2% as converted. Below a €4m exit you receive nothing. Every euro goes to the preference. At €10m the investor still takes their €4m, and the remaining €6m is shared across the other 9,000,000 shares. Only above €22m does converting beat the preference, because 18.2% of €22m is €4m. Above that they give up the preference and take their share instead.

How to calculate a liquidation preference waterfall at exit

To common holders

€24,545,455
Dead zone Total€4,000,000

What an option holder pays to turn an option into a share. Leave at zero for ordinary stock.

Currency

Preferred holders 1

Participating

Higher tiers are paid first. Equal tiers share pro rata.

  • Series A18.2%€5,454,545
  • Founders72.7%€21,818,182
  • Option pool9.1%€2,727,273

What your own stake is worth

One common share is worth€2.7273
Gross at this exit€0
Cost to exercise€0
Before tax, this reaches you€0

After the preferences above are paid and after what exercising costs you. Income tax and social contributions come off this figure, not out of it.

Proceeds across exit values

0€50.0M

Below this exit price, founders and employees receive nothing at all.

  • Series AConverted to common

    Preference
    €0
    Participation
    €5,454,545
    Total
    €5,454,545

  • Founders

    Preference
    €0
    Participation
    €21,818,182
    Total
    €21,818,182

  • Option pool

    Preference
    €0
    Participation
    €2,727,273
    Total
    €2,727,273
How this is calculated
  1. Preferences are paid by seniority. Higher tiers are satisfied in full before lower tiers receive anything; equal tiers share pro rata if the money runs out.
  2. A non-participating holder takes the better of their preference and their as-converted share.
  3. That choice is not made in isolation: converting enlarges the common pool and dilutes everyone else, which can change another holder's decision. The model settles on the outcome where nobody can improve by switching.
  4. Participating holders take their preference and then share the residual, up to any cap. Capping one holder releases money to the others.
  5. Whatever survives the preferences is split pro rata across common shares, the option pool, and anyone who converted.
  6. The total distributed always equals the exit value exactly.
What this model leaves out
  • No escrow, no earnout, no transaction costs. Real deals hold back part of the price and this pays out all of it.
  • Options are exercised only when a share is worth more than the strike, and the holder is paid net of what exercising costs. Below the strike they take nothing and the proceeds stay with the people holding stock.
  • Unvested options are treated exactly like issued shares.

Common questions

What is a liquidation preference?
It is the right of a preferred shareholder to be paid before the common shareholders when the company is sold. A 1x preference on EUR 5m invested means EUR 5m comes off the top of the sale price before founders and employees see anything. It exists because an investor who paid a price based on future growth wants their capital back before the people who paid nothing for their shares take a share of the proceeds. It is the single term with the largest effect on what a founder actually receives, and it is often less negotiated than the valuation.
What is the difference between participating and non-participating preferred?
Non-participating preferred takes the better of two outcomes: its preference amount, or its percentage share as though it had converted to common. It cannot take both. Participating preferred takes its preference and then also shares in what is left, which is why it is sometimes called double dipping. On a EUR 20m exit with EUR 5m of 1x preference over a 25% stake, non-participating takes EUR 5m, and participating takes EUR 5m plus 25% of the remaining EUR 15m, which is EUR 8.75m. The founders pay the difference.
What is the dead zone in an exit?
The dead zone is the range of exit values across which the founders and employees receive nothing extra, because everything above the last dollar goes to satisfying preferences. Sell at EUR 4m against EUR 6m of preferences and the common holders get nothing. Sell at EUR 5m and they still get nothing. The whole of that range is dead to everyone holding common, and the practical consequence is that an offer inside it is worth exactly as much to the team as a lower one. Knowing where the zone ends tells you which offers are worth working for.
What does a 1x non-participating preference mean?
It means the investor gets their money back once, or their percentage of the proceeds, whichever is larger, and not both. It is the founder friendly standard and the term you should be trying to hold. The multiple is the part to watch: a 2x preference means twice the invested amount comes off the top, which on a modest exit can consume everything. A 1x non-participating preference on a large exit is effectively invisible, because the investor's percentage is worth more than their money back and they convert.
How does seniority work when there are several rounds of preferred?
Seniority decides the order in which preferences are paid when there is not enough to pay everyone. Stacked or senior seniority pays the latest round first, on the reasoning that the newest money took the newest risk and is usually the largest cheque. Pari passu pays every preferred holder at the same level, sharing pro rata if the proceeds fall short. On a good exit the distinction never surfaces; on a poor one it decides which investors are made whole and which are not, and it can leave an early investor behind a later one.
Do employee options participate in the exit proceeds?
Only when they are in the money, which is to say only when the exit price per share exceeds the strike. Below that nobody exercises, because paying the strike to receive something worth less than the strike is a loss. This matters more than it sounds: modelling the pool as participating at every exit value understates founder proceeds materially, by 20% on a plausible case. This tool exercises options only when it is rational to and pays the holder net of the strike, because the strike money enters the pot and paying gross would break conservation.

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