Investors will almost always introduce a handful of “Preferences” into the Term Sheet that give them specific rights and options to take their money out before anyone else in the event of a sale or liquidation.

There are two types of preferences you’ll likely encounter:

1. Liquidation Preferences. When the company is sold/liquidated, the investor gets their original investment back or their % of stock – whichever is higher.
2. Participating Preferred. The investor gets their original investment back first, and then also gets their % share of the company value.

There are two ways that this can become a real problem for Founders. First, if the company is sold for an amount less than they have raised in capital (ex. “Raised $2m in capital, sold for $1m”) then the investors would get their money out first, and the Founder would get nothing.

The second is that over time, all of those preference “stack”. Which means if we’ve raised $50m over 4 funding rounds, that entire $50m is a giant preference that would precede a sale. So even if we sold for $50m – we’d still get nothing.

Preferences are very common in term sheets and are quite difficult to negotiate out of. They are designed to be the last line of protection with an investor’s money, so they take that provision incredibly seriously (as they should).