What is Liquidation Preference?

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A liquidation preference is a clause in a contract that dictates the payout order in case of a corporate liquidation. Typically, the company's investors or preferred stockholders get their money back first, ahead of other kinds of stockholders or debtholders, in the event that the company must be liquidated. Liquidation preferences are frequently used in venture capital contracts, "

Definition

Liquidation preference is a contractual provision that dictates the order of payment during a company's liquidation. Typically, in the event of a company's liquidation, investors or preferred shareholders are paid back their funds before other types of shareholders or creditors. Liquidation preference is often used in venture capital agreements.

Origin

The concept of liquidation preference originated from the development of corporate and bankruptcy laws, aimed at protecting investors' interests, especially in high-risk investment environments. With the rise of the venture capital industry, liquidation preference became a crucial clause in investment agreements to ensure investors could recover their investments first in case of company failure.

Categories and Features

Liquidation preferences are generally categorized into participating and non-participating types. Participating liquidation preference allows preferred shareholders to recover their initial investment and also participate in the distribution of remaining assets. Non-participating liquidation preference limits recovery to the initial investment. Participating preference is more favorable to investors but may disadvantage common shareholders.

Case Studies

During the 2008 financial crisis, many companies faced liquidation, and preferred shareholders, such as in the case of Lehman Brothers, used liquidation preference to recover part of their investments. Another example is WeWork's failed IPO in 2019, where SoftBank, as a major investor, exercised its liquidation preference to ensure partial recovery of its investment.

Common Issues

Investors often misunderstand the scope of liquidation preference, assuming it guarantees full recovery of investment in all situations. In reality, the recovery amount depends on the remaining assets of the company. Additionally, the distinction between participating and non-participating preferences is often overlooked, affecting investors' decisions.

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Labor Intensive

The term "labor-intensive" refers to a process or industry that requires a large amount of labor to produce its goods or services. The degree of labor intensity is typically measured in proportion to the amount of capital required to produce the goods or services: the higher the proportion of labor costs required, the more labor-intensive the business.

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Fast-Moving Consumer Goods

Fast-moving consumer goods (FMCGs) are products that sell quickly at relatively low cost. FMCGs have a short shelf life because of high consumer demand (e.g., soft drinks and confections) or because they are perishable (e.g., meat, dairy products, and baked goods).They are bought often, consumed rapidly, priced low, and sold in large quantities. They also have a high turnover on store shelves. The largest FMCG companies by revenue are among the best known, such as Nestle SA. (NSRGY) ($99.32 billion in 2023 earnings) and PepsiCo Inc. (PEP) ($91.47 billion). From the 1980s up to the early 2010s, the FMCG sector was a paradigm of stable and impressive growth; annual revenue was consistently around 9% in the first decade of this century, with returns on invested capital (ROIC) at 22%.

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Negotiable Instruments

A negotiable instrument is a signed document that promises a payment to a specified person or assignee. In other words, it is a formalized type of IOU: A transferable, signed document that promises to pay the bearer a sum of money at a future date or on-demand.Common examples of negotiable instruments include personal checks, cashier's checks, money orders, certificates of deposit (CDs), promissory notes, and traveler's checks. The person receiving the payment, known as the payee, must be named or otherwise indicated on the instrument. Because they are transferable and assignable, some negotiable instruments may trade on a secondary market.

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Renewable Resource

A renewable resource is a resource that can be replenished naturally over time. As a result, it is sustainable despite its consumption by humankind.Renewable resources for the production of energy are considered especially important for their potential to replace non-renewable, or finite, resources. Additionally, renewable resources can offer cleaner energy solutions than those provided by non-renewable resources such as coal and fossil fuels.Examples of renewable resources include the sun, wind, water, the earth's heat (geothermal), and biomass.

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Feasibility Study

A feasibility study is a detailed analysis that considers all of the critical aspects of a proposed project in order to determine the likelihood of it succeeding.Success in business may be defined primarily by return on investment, meaning that the project will generate enough profit to justify the investment. However, many other important factors may be identified on the plus or minus side, such as community reaction and environmental impact.Although feasibility studies can help project managers determine the risk and return of pursuing a plan of action, several steps should be considered before moving forward.