Liquidation Preference's/ VC Conflicts

Venture capitalists are waking up to a new and uncomfortable problem: typically collaborative investors are finding themselves at odds with each other when portfolio companies move to exit or initiates a new fund raising round.

The complications involve liquidation preferences for different share classes—seed, Series A, B and C, and so on. Shares sold in later rounds, the ones further down in the alphabet, are known as senior shares because they are at the top of the liquidation preference stack and should be worth more. When a company's value drops below the total capital invested, backers in the latest round get their money back first—assuming the company has a standard structure of liquidation preferences.

None of this mattered much during the boom times unlike since past half a decade. Back then, just about everyone was feeling optimistic about their portfolio companies growing into massive businesses. Investors didn't spend a lot of time thinking about their downside protection.

All that ended when the US Federal Reserve turned off the money spigot by raising interest rates. Comparable company valuations dropped, growth slowed and now, more than 18 months into the downturn, some portfolio companies are worth less than the money they raised.This complicated economic picture is colliding with convoluted share structures. The result is that various share classes may now root for competing outcomes as portfolio companies seek liquidity or new rounds of financing.

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