A “Liquidation Preference” is the right of holders of Preferred Stock to have priority over holders of Common Stock with regards to the distribution of proceeds from a Liquidity Event. The Liquidation Preference is calculated based on the price paid for a share of Preferred Stock times a multiple, usually 1x, 2x or 3x, plus all accrued and unpaid Dividends.
For example, in the event of a Liquidity Event, a holder of Preferred Stock with a 2x Liquidation Preference who paid $100,000 for all of such holder’s shares of Preferred Stock will receive a Liquidation Preference distribution of $200,000, plus all accrued and unpaid Dividends, before the holders of Common Stock receive any distribution from the Liquidity Event.
Participating Preferred Stock is an additional right that enhances the Liquidation Preference by allowing a holder of Preferred Stock to also receive a Pro Rata Portion (based on an As Converted to Common Stock Basis) of the Liquidity Event distribution to holders of Common Stock.
The Liquidation Preference is documented in the Certificate of Incorporation (or, as applicable, the Articles of Incorporation).