Liquidation Preferences, a Waterfall Analysis, and Educating Startup Employees

TL;DR I’ve uploaded an easily-manipulated liquidation model to better educate employees, founders, and anyone else interested in how liquidation preferences affect financial distributions across a variety of exit scenarios. Just make a copy on Google Docs and edit away.

Last weekend Heidi Roizen wrote a great post titled How to Build a Unicorn From Scratch – and Walk Away with Nothing. The post illustrates how liquidation preferences (among other things) affect investors, founders, and employees through the story of a fictional, high-flying startup called Pied Piper.

While I couldn’t understand why the tech world just now decided to talk about something that has been in term sheets for as long as I can remember, I have for some time believed that employees are often undereducated in regards to what their options may be worth in reality.

So I tweeted this in response to Heidi’s post:

Anand replied and we discussed how increased transparency would be great for startup employees. To that point, I’ve built a liquidation model to perform what is known as a waterfall analysis. I used the bones of a model from a 2011 Fred Wilson post, but went on to add a seed round, change the terms to more closely mirror financing conditions in 2015, and automate the majority of the doc.

In my model, all inputs are in red text. Change the size of any round or the share price on the cap table, or the exit amount on the waterfall analysis tab, and the rest of the document will update.

The waterfall analysis takes into account a variety of exit scenarios and shows how liquidation preferences can affect where the proceeds of an exit go. This data can be used for both employees and founders to better understand how they can be affected by things such as stacked liquidation preferences over the course of their company’s financing history.

While this type of granular data may be hard to come by for employees at later-stage companies, I believe that things like my model and posts like Heidi’s are a great step towards better transparency, education, and awareness of some of the more nuanced parts of our venture capital and startup ecosystems.

If you have any comments or questions, please don’t hesitate to reach out via email or on twitter @mhdempsey.

1 comment

  • Hello! This is really helpful. Just a quick question. Why doesn’t cell F7 take the shares in cell D14 into account? Is that an oversight or is there a reason why the seed round shares wouldn’t be be calculated in post-valuations starting in Round A and beyond? Thanks! Great read, great resource.