What’s liquidation desire?Liquidation desire refers to most well-liked shareholders’ rights to obtain a specific amount for the popular shares they maintain rather than widespread shareholders within the occasion that the corporate goes into liquidation.The scope of liquidation desire varies between completely different time period sheets. Some could also be extraordinarily favorable to traders, some could also be much less. Nevertheless, the aim of liquidation desire is such that within the occasion an organization goes into liquidation, most well-liked shareholders will all the time get one thing again for his or her most well-liked shares earlier than widespread shareholders get something. In different phrases, they may all the time get greater than widespread shareholders. It’s attainable that widespread shareholders will get nothing if the corporate doesn’t even have sufficient belongings to settle the desire quantity.Instance A:Enterprise Tech Ltd. has 5,000,000 widespread shares excellent.In a Sequence A financing, Buyers A invests $2,000,000 in return for two,500,000 Sequence A Most well-liked Shares (i.e., buy worth per share = $zero.eight).The time period sheet of this Sequence A spherical gives that:
Within the occasion of a liquidation occasion, the popular shareholders can be entitled to obtain rather than widespread shareholders an quantity equal to 2 occasions the acquisition worth per share, plus declared and unpaid dividends (the “Initial Payment”). After the Preliminary Cost has been made in full, any belongings remaining shall be distributed to the popular shareholders (on an as-converted foundation) and customary shareholders on a professional rata foundation.NOW, Enterprise Tech Ltd. goes into liquidation and the sale worth is US$6 million.Assuming no declared and unpaid dividends, and all different senior money owed, e.g., staff’ wages, secured money owed, and many others., have all been settled:How a lot will the popular shareholders get?They first get US$zero.eight x 2 = US$1.6 for each most well-liked shares they maintain.Subsequently, the Preliminary Cost is US$1.6 x 2.5 million = US$four million.This offers US$2 million ($6 – $four million) remaining, which shall be distributed to the popular shareholders and customary shareholders on a professional rata foundation.Subsequently, most well-liked shareholders will get an extra US$2 million x 2.5 / 7.5 = US$666,666.I.e., a complete of US$four,666.666.The widespread shareholders will get a complete of US$2 million x four / 7.5 = US$1.333,333.Whole = US$four,666,666 + US$1,333,333 = US$6 millionExample B:Following instance A above, as an example this time the sale worth is US$10 million.They’ll get a complete of $four million (the Preliminary Cost) + $6 million x 2.5 / 7.5 = $6 millionThe widespread shareholders will get a complete of $four million.Instance C (firm favored):Let’s give it a twist. This time every thing is identical as above besides that the full quantity the popular shareholders will get for every most well-liked share they maintain is capped at four occasions the acquisition worth per share.In different phrases, they first get 2 occasions the acquisition worth per share rather than widespread shareholders (i.e., the Preliminary Cost as in Instance A and B). All remaining belongings will then be distributed amongst them and customary shareholders till the popular shareholders have obtained four occasions the acquisition worth per share (plus unpaid however declared fee, and the Preliminary Cost). All remaining belongings thereafter can be distributed amongst all widespread shareholders on a professional rata foundation.
NOW, let’s do the maths:Placing apart the sale worth, because the most whole quantity the popular shareholders can get is capped at four occasions the acquisition worth per worth, they in any occasion will get not more than four x $2 million = $eight million (nonetheless excessive the sale worth could also be).What’s the break even level for the sale worth?Let y be the break even sale worth:(y – four) (2.5 / 7.5) = eight – four
y = 16Subsequently, the break even sale worth is US$16 million.Subsequently, the sale worth should be a minimum of US$16 million for the popular shareholders to get US$eight million. If the sale worth exceeds US$16 million, they may nonetheless get solely US8 million, because the most quantity they will get is capped.That is why by setting a cap on the liquidation quantity the popular shareholders can get is company-favored.