Liquidation preferences quietly determine who actually gets paid in a sale. Two cap tables that look identical in ownership percentages can produce wildly different founder outcomes at exit because the preferred stack is different. Modelling waterfalls is a non-optional skill.
Non-participating preferred
Holder gets either their preference back or their as-converted pro-rata share, whichever is greater. At low exit prices, the holder takes the preference. At high exit prices, the holder converts and takes the pro-rata share. There is a single break-even price above which conversion is preferred.
Example: $20M Series A at 25% post-money ownership ($80M post). At $40M exit, holder takes $20M (preference); at $200M exit, holder converts and takes $50M (25% pro-rata). The break-even is $80M — below it the preference dominates, above it the equity dominates.
Participating preferred
Holder takes their preference and their pro-rata share of remaining proceeds. At every exit price, the participating holder receives more than a non-participating holder would. The cost falls on common (founders and employees).
Modern markets typically resist full participating preferred outside specific situations (down-round bridges, distressed financings); capped participating — participation up to a 2x or 3x multiple, then converts to non-participating — is sometimes seen.
Stacked preferences across multiple rounds
After a Series A, B, C, D, the cap table has a stack of preferences. Pari passu: all preferences rank equally. Senior: the latest series ranks ahead of earlier ones (common in distressed bridges). The stack determines waterfall payment order at any exit price.
How to model it
A waterfall model: at each exit price, walk through the preference stack from senior to junior, paying each preference; then split the remainder between participating preferred (if any) and converting / common. Build a chart from $0 to $1B exit price showing the payout to each share class. The chart immediately reveals where founder economics are real and where the structure has hollowed them out.