Venture Financing Tips: Protective Provisions, Liquid Preferences, & Participating Preferred Stock

Hear from Jesse Jones, Fourscore Business Law Founder, about How To Structure an Equity Deal. In this video, learn about 3 important terms when structuring an equity deal. He'll discuss the difference between protective provisions, liquidation preferences, and participating preferred stock. Stay tuned for the next video in our Venture Financing Tips series and subscribe to our monthly newsletter full of resources here. For entrepreneurs, the prospect of raising funds to propel business growth should come with a mix of excitement and fear. While taking angel and venture capital isn’t right for every startup, it may be the ideal financial structure to help you scale. Venture capital gives you the opportunity to raise significant amounts of funding by essentially selling a part of your company as you build it. For that reason, entrepreneurs should understand that angel and venture capital is typically expensive money, so the smartest entrepreneurs will make sure to seek outside capital from those that can provide value in terms other than simply dollars. If you are planning to meet with a potential investor, understanding what to expect when it comes to structuring venture deals will help ensure you get started on the right foot. Download our whitepaper here, including a directory of funding sources in North Carolina and the Southeast.

Venture Financing Tips: Protective Provisions, Liquid Preferences,& Participating Preferred Stock

Hi, I'm Jesse Jones, founder of Fourscore Business Law. Thanks for tuning in to this quick video on

how to structure an equity deal. We're going to go over three important terms that you're going to

see in a venture term sheet.

Protective provisions, liquidation preferences, and participating preferred stock. Protective

provisions are provisions that will be placed in the amended and restated charter and will give

investors certain consent rights over certain things that the company might want to do. It could be

the investors themselves as a subset of the shareholders that have to give consent, or it could be

the investor board member if the investors are going to put a director on the board of a company

in connection with the financing.

But protective provisions give consent rights to the investors over things like executive pay,

increasing the stock option pool, selling additional shares of stock, that type of thing. Liquidation

preferences, this is a very important right, probably one of the most important things that

investors are going to ask for in an equity deal. A liquidation preference allows the investor to get

their money out of the company before the founders do.

So when the company is sold, there's going to be a pot of money that's going to be divided up

among the shareholders. The liquidation preference, however, will say that the investors get paid

out first. So that goes hand in hand with participating versus non-participating preferred stock,

which is what we're going to talk about next.

So participating preferred stock would say that the investors are going to get their money back,

their initial money back, plus they're going to share with the common stockholders pro rata. That's

pretty uncommon. You'll see it in later stage deals, but in early stage seed and series A deals,

that's not normal.

It's unusual, but it is there. Non-participating preferred stock. Now that is sort of more normal.

And what that says is in conjunction with the liquidation preference, the investors get to decide.

They either get their money back, they get their preference, and their preference could be one,

it's normally one times their money, so they get their money back. It could be two times, it could

be three times, whatever. That could be a negotiating point, but most commonly you're going to see a 1x

liquidation preference. Non-participating preferred stock says that the investors choose. They either

get their money back or, or, not and, or they get to share with the common stockholders pro rata.

So if the deal is, if the company is sold and the share price is not enough to make a good return

for the investors, they're going to take their money back. However, if it's a great return, they'd be

better off sharing pro rata. And so that's what they'll choose.

For more information on how to structure an equity deal, check out the venture white paper at

fourscorelaw.com. Thanks.

Common Questions About Protective Provisions, Liquid Preferences,& Participating Preferred Stock

• Q: What is a liquidation preference in a startup investment deal?

  A: A liquidation preference gives investors the right to get their money back before founders when a company is sold. Most deals use a 1x liquidation preference, meaning investors recover their original investment first before proceeds are split with other shareholders.

• Q: What's the difference between participating and non-participating preferred stock?

  A: Non-participating preferred stock means investors choose between getting their money back or sharing proceeds with common stockholders — not both. Participating preferred stock lets investors do both, but that structure is rare and mostly seen in later-stage deals.

• Q: What are protective provisions in a NC venture financing term sheet?

  A: Protective provisions give investors veto or consent rights over key company decisions, like executive pay, issuing new stock, or expanding the stock option pool. These rights are written into the company's charter and can be held by investors directly or through a board seat.

• Q: Do early-stage startups typically offer participating preferred stock to investors?

  A: No — participating preferred stock is uncommon in seed and Series A deals. Non-participating preferred stock is the standard structure for early-stage venture financing rounds.