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Hey {{first_name}} 👋, I hope you’re having a great week! In the last issue we covered secondary sales, and why common stock trades 20-40% below the last preferred round. Today we unpack the reason behind that discount.

Let’s talk about ⬇️

A strong candidate is weighing your offer against another one. They’ve got 1% on the table. They ask the finance lead a reasonable question.

The honest answer is that 1% means nothing by itself.

1% of a company with a modest preference stack and a credible path to a $200M exit can be worth millions.

1% of a company sitting on $60M of stacked liquidation preferences, with a realistic exit range of $80-120M, may be worth very little. Most of the proceeds get absorbed before common stock sees a dollar.

Same percentage. Completely different outcome.

The difference lives in the gap between two share classes. And last issue’s 20-40% secondary discount on common stock comes from exactly the same place.

Common stock is what founders hold from formation and what employees receive through option plans. It votes. It has no special financial protections. In a sale or liquidation, common gets paid last.

Preferred stock is what investors get for their capital in a priced round. It sits ahead of common and comes with a negotiated package:

The liquidation preference is the one that decides how exit money gets split. Three structures show up in practice.

The slide: cap table summary ahead of a refresh grant discussion. Founders 42%. Option pool 14%. Investors 44%. Clean pie chart.

What wasn’t there: a single dollar figure.

The board was about to approve refresh grants with no view of what those grants were worth at a realistic exit. Two of the last three rounds had added senior preferred. Nobody had checked where the conversion point had moved.

The fix: pair ownership percentages with a waterfall at three or four exit values. Disappointing, base, strong, breakout. One extra table, and the refresh conversation becomes about actual value.

Every exit pays out in the same sequence.

A company raises a $10M Series A for 20% fully diluted. 1x non-participating. Common holds the other 80%.

$20M exit. Preferred’s as-converted share would be $4M. Their preference is $10M, so they take the $10M. Common splits the remaining $10M.

$60M exit. As-converted share is $12M, which beats the $10M preference. Preferred converts. Common takes $48M.

$150M exit. As-converted is $30M. Preferred converts. Common takes $120M.

The crossover sits at $50M, where 20% of the exit equals the $10M preference. Below that line, the preference decides the outcome. Above it, ownership percentage does.

That crossover is the single most useful number on your cap table. Calculate it before every raise.

Now change one word. Same deal, but 1x participating.

At the $60M exit, preferred takes the $10M preference first. Then they also take 20% of the remaining $50M, another $10M.

Preferred walks away with $20M. Common gets $40M.

Every round adds to the stack.

A company that raised $40M in preferred across four rounds needs a much bigger exit before common clears the stack than one that raised $15M. Each new round can push the conversion point higher, which quietly changes what every existing option grant is worth.

Model your own waterfall before every raise. Don’t work from the investor’s summary. Build it across a disappointing exit, a base case, a strong case, and a breakout. See where conversion falls in each.

Negotiate preference terms as hard as valuation. A higher valuation with participating preferred can leave founders and employees worse off than a lower valuation with clean 1x non-participating terms. The headline number is the one in the press release. The preference terms are the ones that pay out.

Give candidates real numbers. An equity offer needs three things attached: the strike price, the total preference stack ahead of it, and the fully diluted share count. If finance can’t answer those cleanly, the gap shows up at the worst moment. A competing offer, or an actual exit.

Valuation as the only lever. Founders trade clean terms for a bigger headline. Run the waterfall on both term sheets before deciding which is richer.

Granting equity without checking the conversion point. Then an offer arrives below the stack and the conversations get awkward. Run the waterfall at grant, and again at every round.

Skipping anti-dilution and protective provisions. They matter as much as the preference in a down round or a contested board vote. Go line by line with counsel, and flag anything that needs investor consent for decisions you’ll need to make quickly. The NVCA model term sheet is a good baseline for what standard looks like.

Assuming rounds stack cleanly. Some later investors negotiate seniority over earlier preferred. Confirm the stacking order in every new term sheet and tell prior investors before you sign.

Reporting ownership in percentages only. See the board deck segment above.

Preferred and common are two different contracts with different claims on the same future cash. In every exit short of a breakout, the terms attached to each class decide who captures the value.

Three things to carry out of this.

Know your crossover point. Below it, preferences decide the payout. Above it, ownership does.

Defend 1x non-participating. Participation and multiples move real money without adding capital.

Attach dollars to every equity conversation. Candidates, refresh grants, and board updates all deserve a waterfall view.

For finance leads, the waterfall model is one of the highest-leverage things you can own. It answers the candidate’s question, the board’s question, and the founder’s question with the same spreadsheet.

Reply “WATERFALL” and I’ll send the liquidation waterfall model. Multiple preferred rounds with seniority, participating vs non-participating toggle, conversion logic for each series, and payouts by holder at any exit value.

Valencia finally dropped below 20 degrees and everyone’s dressed for a ski trip.

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