Liquidation preferences matter!

Today's post is a shout-out to a piece by Trent Dykes on The Venture Alley.

Trent gives us the up-shot of a much-watched case having to do with the legal duties faced by directors in approving the sale of a company where the preferred shareholders will receive proceeds, but the common shareholder will receive nothing.

5486734383_26a5db3611_zIn this particular case, In re Trados Incorporated Shareholder Litigation, the directors were found to have not breached duties to common shareholders.

Big picture, the case is a reminder that liquidation preferences really do matter. Directors will have duties to all shareholders, of course, when considering whether or not to sell a venture. But it's also quite possible, and not at all uncommon, for a company to be sold in circumstances where the preferred shareholders will see a return and the common shareholders will receive . . . nothing.

I find this excerpt from Trent's post to be particulary instructive:

"Private equity and venture-backed company can sometimes find themselves in the difficult situation where the timing of the major investors’ need for liquidity (due to such investors’ investment time horizon) does not align with the company’s ability to obtain an optimal liquidity event (either in time or value)."

That's the tension, isn't it.

Almost all venture investors want liquidity at some point, but some venture investors have institutional imperatives for it. That's a critical factor to consider, not just when constructing liquidation preferences but in choosing what investors to let in.

Photo: schmechf / Flickr.

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