Expert360, the Sydney consulting marketplace founded in 2013, has been sold to AI job-matching platform Swipejobs for a reported $16 million. The company had raised around $30 million over its life. Under the sale’s terms, only holders of Series C and C1 preference shares receive anything. The founder, the early investors and the employees holding equity receive nothing. (SmartCompany, Startup Daily)

This isn’t a story about predatory investors. Several of the venture funds that backed earlier rounds are also reported to walk away with nothing, through exactly the same mechanism. It isn’t a story about a founder who didn’t work hard enough either. More than a decade went into the business, and it was one of the standout Australian startups of the 2010s. The founder put it plainly herself: “Founders are paid last. That’s the deal you sign, and I’d sign it again.”

What it does show is how liquidation preferences work once several rounds are stacked on top of each other, and how rarely founders model that before they sign. In this article, we explain what a liquidation preference is, how the preference stack builds up round by round, the number every founder should be able to quote before signing a term sheet, and the terms worth looking at closely while you still have room to negotiate them.

What a liquidation preference does

A liquidation preference is the right to get your money back first when the company is sold or wound up, ahead of ordinary shareholders. Investors usually get it by buying preference shares rather than ordinary shares.

The most common form is a 1x non-participating preference. When the company is sold, the investor chooses whichever is worth more: their original investment back, or converting to ordinary shares and taking their percentage of the sale price. If they put in $5 million for 20% and the company sells for $100 million, they convert and take $20 million. If it sells for $15 million, they take their $5 million back instead of the $3 million their 20% would be worth.

On its own, that’s a reasonable term. The investor is taking risk on a business with no certain outcome and wants protection if things go sideways. It’s market standard for good reason.

How the preference stack builds up

A single 1x preference rarely causes a problem. The trouble starts when every round adds another one on top.

Each round you raise adds another layer of money that has to be repaid before ordinary shares are worth anything. That total is your preference stack. How it pays out depends on how the rounds rank against each other:

• Stacked (senior) preferences. The newest round is repaid first, then the round before it, and so on down. This is common in later rounds, and it’s the structure that left Expert360’s earlier investors with nothing.
• Equal ranking (pari passu). All preference holders share whatever is available in proportion to what they’re owed. Everyone takes a haircut, but no round is wiped out completely while another is paid in full.

Here’s how that plays out. Say a startup raised a $3 million seed round, an $8 million Series A and a $20 million Series B, all with 1x non-participating preferences – $31 million in total. It sells for $25 million.

With stacked preferences, Series B takes its $20 million, Series A gets the remaining $5 million, and the seed investors, founders and option holders get nothing. If all three rounds rank equally instead, each investor recovers about 81 cents in the dollar. The founders and the team still get nothing in both cases, because the sale price never gets past the $31 million stack.

That’s the Expert360 picture. A sale price of $16 million against around $30 million raised runs out well before it reaches the ordinary shares. The waterfall wasn’t set in the sale negotiation. It was built years earlier, one term sheet at a time.

The number every founder should be able to quote

There’s one question worth answering before you sign any term sheet: what does the company have to sell for before your ordinary shares are worth anything?

That number moves every time you raise. A $5 million round at a strong valuation feels like a win on the day it closes. It also raises the sale price your exit has to clear by at least $5 million, and by more if the preference is participating or carries a multiple.

Most founders can tell you their last valuation without looking it up. Very few can tell you this number, and it’s the one that decides what they walk away with in anything short of a big exit. Our free cap table template for startups is a good place to start pulling your rounds together.

The terms worth looking at before you sign

None of these are unusual requests. They’re the questions an experienced adviser asks at every round, and they’re far easier to shape at term sheet stage than at exit.

• Model the waterfall at every term sheet, not at exit. Look at what each shareholder receives if the company sells for half the post-money valuation, at the post-money valuation and at three times it. The upside case looks fine under almost any structure, which is why it’s the one founders tend to look at. The downside cases are the ones that show you what the terms really mean.
• Treat valuation and terms as one negotiation. A higher headline valuation with a 2x participating preference can leave you worse off than a lower valuation on a clean 1x non-participating preference. Investors will often agree to the valuation you want in exchange for the structure they want, so be clear on what you’re trading.
• Ask where the new money ranks. Will the new round sit senior to existing preference shares, or rank equally with them? Stacked seniority is what turns a modest exit into nothing at all for everyone below the top layer.
• Agree what your team gets in a downside sale early. Option holders sit at the very back of the queue. In a sale like Expert360’s, they get the same as the founders – nothing – often after taking a lower salary for years on the strength of that equity. If you want your team to see something from a modest sale, a management incentive or transaction bonus pool has to be agreed while you still have leverage, not once a buyer is at the table.
• Raise what you need rather than the most you can. Every dollar of preference is a dollar ahead of you in a modest exit. When the realistic outcome is a trade sale rather than an IPO, that trade-off matters.
• Read the drag-along clause. A drag-along lets a set majority of shareholders force everyone else to accept a sale, including a sale that pays you nothing. Understand the threshold and who controls it when you sign, not when the notice arrives.

If you’d like more on the wider picture, we cover how debt, preference shares and ordinary equity fit together in What Is a Capital Stack? How Aussie Startups Should Think About Funding Structure, and the record-keeping side in The Cap Table Mistakes That Come Back to Haunt You.

Why this matters more in the current market

For a lot of good Australian startups right now, the realistic exit is a trade sale at a price that might have looked disappointing a few years ago, rather than a float or a headline acquisition. That’s the scenario your preference stack needs to hold up in, not the one on the vision slide of your pitch deck.

None of this is an argument against raising. It’s an argument for knowing, at every round, exactly what you’re agreeing to and what it costs you at the exit values that are actually likely. That means knowing what sits on your share register, in what order it gets paid, and what the company has to sell for before your shares and your team’s options are worth anything. Those numbers change with every round you close, so they’re worth keeping current as you raise, and essential once an exit is on the table.

It’s a modelling exercise, and one our fractional CFO team works through with founders alongside our cap table management services.

Know your preference stack before your next raise

Disclaimer: This article is for general informational purposes only and does not constitute financial, legal or tax advice. Term sheet and shareholder agreement terms vary a lot between deals, so please speak with a qualified adviser (hey, that’s us!) before you sign.