It’s the middling outcomes that investors are optimizing the downside for, the OK ones. Investors don’t take their preference, they convert to common and take their fair share (unless they have participating preferred and they get both their investment and their unfair share). When you kill it, this liquidation stuff doesn’t matter that much as it’s bottles and models for everyone. There is something and investors want it all. Some companies raise a lot of money and get a meager outcome. Most startups go the way of the dodo, and investors know this. The first preferred stocks were issued by railroad companies and canals in the mid-1800s who wanted to sweeten deals to get the funding they wanted. Preference shares or again… preferred stock’s etymology is from ‘liquidation preference’. You totally will expect to get more, this is just a random example I made for illustration purposes. The top graph is a % of the total return and the bottom graph is the dollar return that is paid out. The small brown bar near the top is common stock… what the founders have. The blue is Series-I preference shares and the orange is Series-H. You can see it starts all blue and then fades down over time. Here is an example from my cap table returns analysis. You, the founders with common stock are at the bottom of the waterfall, hoping a huge pool will be made, not a barren swamp. When you exit your startup and the water gushes out with cash, the water flows down with the latest class of investor stock getting first dibs on it. Like going up a waterfall, each new class is ranked higher than the other and the money water splashes on them first. It is worth understanding that in every new round of investment there will most likely be a new ‘class’ of preferred or preference share which will be issued. There is a list of potential rights which we will discuss later. When you create this new class of shares, certain rights and privileges are afforded to them. One way to think about preferred shares is like debt with no interest, but repayment happens on exit since there are features you might understand from getting a mortgage. They’re special, sort of why they are also called ‘preferred stock’.
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