In addition to defining the liquidation event, a liquidation preference clause must also specify how the value should be distributed. This may be based on a formula or percentages or a formula for a shareholder and percentages for the rest. Non-participating, which gives investors the right to recoup an amount equivalent to their investment in the holding company or a multiple of it (for example. B, double or triple the investment). Upon receipt of the preferential amount, the remaining revenues are distributed to other shareholders, so that the investor does not participate in this distribution. This type of liquidation preference tends to be the most favorable for the founders of the company. Liquidation preferences can be simple or complicated. This is a way to change investment returns relative to equity ownership when planning the exit. Unless shareholders are investors who need a highly structured return profile (usually when a significant investment has been made), the additional complication of having one does not justify the benefits. A liquidation preference gives some shareholders, compared to others, the right to obtain a greater portion of the company`s residual value in the event of a liquidation event.
The liquidation preference relates to the priority of certain shareholders over other shareholders to obtain the distribution of residual assets and to realize liquidation income when the entity enters the liquidation procedure or in the event of an alleged liquidation event. There are two types of circumstances that trigger the liquidation preference: (1) the liquidation facts covered by section 180 of the Corporations Act; and (2) liquidation events agreed between shareholders, including the acquisition of the company, the transfer of shares of controlling shareholders, the modification of the effective controllers and the disposal of the company`s principal assets. There are certain situations in which the investor has the option to choose the method of liquidation following a liquidation event. The investor can choose the option that would provide him with high revenues. It is customary for all investors to have the same rights to participate in the event of a liquidity event. However, in some cases, it has also emerged that the investor who has recently invested in the business has a first preference when a liquidity event occurs. However, the understanding of the provisions of public law should be determined by the legal relationship governed by specific provisions. For example, „the distribution of residual assets among shareholders, after settling the company`s claims,“ as stipulated in section 186 of corporate law, falls within the scope of private law. If the shareholders concerned enter into a separate distribution agreement, the application of the provisions should be excluded. All of this must be formulated very carefully in the articles in order to comply with the SEIS/EIS. The good news is that at SeedLegals, we`ve done all the research and hard work for you, and if an investor asks for a liquidation priority for his SEIS/EIS investment, you can set it up with just a few clicks, with the assurance that the formulation will be correct.