[prostoalex]

I forgot about the debt holders. So if there was any debt (including un-converted convertible notes), the pecking order is:

1) Debt holders

2) Most senior shareholders and their liquidation preference

3) Less senior shareholders and their liquidation preference

...

99) Common stock holders

This is actually to align the founder incentives in shooting for a big exit. Insert any other order of preferences, and the founders have a stronger incentive to flip the company as quickly as possible in order to create a payday for themselves, screwing investors in the process (which also happens to be a very irrational proposal for investors, which is why you rarely see a round on those terms).

[adventured]

Investors don't inherently get screwed in the process of a quick flip if they have common shares. It means the investor is directly aligned with the founders, and makes it harder for the investor to get a return at the expense of the founders.

Investor puts in $1m for 20%.

Founders quick flip for $30m. The investor just made six times his money, and earned a payout fully aligned with the founders. Absolutely nobody got screwed.

The reason investors like liquidation preferences, is so they can improve their odds of getting their money back at least (and yielding the first dollars of return). They aren't aligning their interests with the founders in this case, they're putting their interests in front of the founders, just as debt does. Liquidation preferences are a way of saying: my equity is more important than your equity; you need my money, so I'm going to make sure my money is treated with more importance than your equity.

Liquidation preferences exist solely to protect investors from their own poor choices at the expense of the founders / earlier shareholders.

[leereeves]

Liquidation preferences exist to protect against a company raising $10 million for 20% and selling for $5 million, with the founders taking a nice payoff of $4 million and the investor losing all but $1 million.

In that scenario, without liquidation preferences, the interests of the founders and investors aren't aligned--the founders profit while the investors lose money.

[alain94040]

Try again with an exit at $2M and you'll see why the investors wouldn't be happy with common stock.

[daemin]

So does this mean employees could be owed something in terms of debt (i.e. if they haven't had their benefits paid out fully) or are they what I assume:

100) Employees

[troels]

Depends on the jurisdiction of course, but generally salaries would be first in line.

[KayEss]

Number one preference is the tax man isn't it? At least in the UK, he always gets paid first.

[RobAley]

That's not been true for a long time. The only "preferential creditor" in the UK now are employees, HMRC take their chances with all other debtors.

[KayEss]

My knowledge of this comes from the dot com crash 15 years ago. I'm pleased that the employees now come ahead of the tax man.

[prostoalex]

In the US you'd have to make a profit to have the tax liability, and if that's the case, the company is unlikely to be going through a fire sale. There's a host of payroll taxes associated with employees, but those get paid as employees get their paychecks, so qualifies under "debt".

[vidarh]

See item 1) debt holders. Within the class of debt holders, the tax man and/or employees with salary claims often have special preference amongst creditors in many countries.