Two ways to rank the same 1x non-participating preferences, worked across a range of exits, and the band where the choice moves real money.
Seniority only matters when the exit is below the total preference stack. With 1x non-participating preferences of 20.00, 8.00 and 2.00, a 24.00 exit pays the Series B in full, the Series A 0.50x and the seed nothing when the series are stacked; pari passu pays all three 0.80x. Above the 30.00 stack the two structures pay exactly the same.
Worked in full in The Venture Capital Associate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The liquidation preference clause has two dimensions that are often confused. The multiple and participation decide how much each series can claim; seniority decides the order in which the claims are met. An associate reading a term sheet for a later round needs to know where the order bites, because that is where a new lead's request for seniority costs the earlier investors money.
| Class | Invested = preference | As-converted ownership |
|---|---|---|
| Series B | 20.00 | 25.0% |
| Series A | 8.00 | 20.0% |
| Seed | 2.00 | 10.0% |
| Common and options | 45.0% | |
| Preference stack | 30.00 |
The Series B priced the company at 80.00 post-money. Two rankings are compared: stacked, where the Series B is paid first, then the Series A, then the seed; and pari passu, where all three share in proportion to their preferences.
Take a sale at 24.00, less than the 30.00 of preferences. Nobody converts, because 25 per cent of 24.00 is worth far less than any preference.
Stacked: Series B takes min(24.00, 20.00) = 20.00; Series A takes min(4.00, 8.00) = 4.00; seed takes 0.00
Pari passu: each series receives its preference × 24.00 ÷ 30.00 = 80.0%: 16.00, 6.40 and 1.60
In Excel, pari passu: =Pref_i*MIN(1,Exit/SUM(Prefs)); stacked: =MIN(Pref_i,MAX(0,Exit-SUM(Senior_Prefs))).
| Class | Stacked | Multiple | Pari passu | Multiple |
|---|---|---|---|---|
| Series B | 20.00 | 1.00x | 16.00 | 0.80x |
| Series A | 4.00 | 0.50x | 6.40 | 0.80x |
| Seed | 0.00 | 0.00x | 1.60 | 0.80x |
| Common | 0.00 | 0.00 | ||
| Total | 24.00 | 24.00 |
The choice moves 4.00 from the Series A and seed to the Series B. Under stacking the seed receives anything only above 28.00, when the Series B and Series A are both whole.
Above the stack, each series compares its preference with its as-converted share and takes the larger. A series converts once its percentage of what is left after the senior claims beats its preference, so the conversion test has to be run as a set, not one series at a time.
| Exit | Series B | Series A | Seed | Common | Who converts |
|---|---|---|---|---|---|
| 10.00 | 10.00 / 6.67 | 0.00 / 2.67 | 0.00 / 0.67 | 0.00 | None |
| 20.00 | 20.00 / 13.33 | 0.00 / 5.33 | 0.00 / 1.33 | 0.00 | None |
| 24.00 | 20.00 / 16.00 | 4.00 / 6.40 | 0.00 / 1.60 | 0.00 | None |
| 30.00 | 20.00 | 8.00 | 2.00 | 0.00 | None |
| 40.00 | 20.00 | 8.00 | 2.18 | 9.82 | Seed |
| 60.00 | 20.00 | 10.67 | 5.33 | 24.00 | Seed, Series A |
| 100.00 | 25.00 | 20.00 | 10.00 | 45.00 | All |
From 30.00 upwards the two columns merge. Every preference is covered, the residual goes to the common and to the series that converted, and the order in which the preferences were paid is irrelevant because all of them were. At 40.00 the seed converts: 12.00 is left after the Series A and B preferences, and the seed's 10 points out of the 55 per cent that then holds as common are worth 2.18, more than its 2.00. The Series B, the most expensive money, converts last, above its own 80.00 post-money.
The band that matters: seniority changes outcomes only between zero and the total of the preferences, here 0.00 to 30.00, which is 37.5 per cent of the last post-money. For a company sold well above its last round it is worth nothing; for a soft landing it is worth everything.
Treating pari passu as equal shares. Pari passu is pro rata to the preference amount, not per head and not by ownership. At 24.00 the seed holds 10 per cent of the company but receives 1.60, 6.7 per cent of the proceeds, because its preference is 2.00 of a 30.00 stack. The second mistake is to model a seniority request as costless because the base case exits well above the stack. The relevant question for an existing investor is the probability of an exit below 30.00, and in venture that is rarely small: the conversion arithmetic for a single senior series is worked in at what exit a 1x non-participating preference converts.
Hybrids are common too: the Series B senior and the earlier series pari passu with each other. Run them with the same two formulas, tier by tier: pay the senior tier, then share what is left pro rata inside the next tier.
Seniority is a contract about the downside. Here it moves 4.00 between investors at a 24.00 exit and nothing at any exit above 30.00. When a new lead asks for it, price the band, not the base case. A blank model set and three cases that go with the book are in the free companion files; how participation changes the picture is in how participating preferred with a cap works at exit.
All preferred series rank equally and share the proceeds in proportion to their preference amounts until the stack is covered. With 30.00 of preferences and a 24.00 exit, each series receives 80.0 per cent of its preference: 16.00 to the Series B, 6.40 to the Series A and 1.60 to the seed. Common shareholders receive nothing until all preferences are paid.
Both are common and it is negotiated round by round. A new lead investor often asks for seniority over earlier series; earlier investors resist because it moves value to the new money only when the company sells for less than the stack. In this example seniority moves 4.00 from earlier investors to the Series B at a 24.00 exit, and nothing at any exit above 30.00.
With 1x non-participating preferences, common shareholders receive nothing until the full stack, 30.00 here, is paid, whichever seniority applies. At a 40.00 exit the seed converts and common receives 9.82; at 100.00 every series converts and common receives its 45.0 per cent, 45.00.
This article is one calculation from The Venture Capital Associate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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