What is liquidation?
Liquidation is the process by which a company is wound up: its assets are sold or distributed, its liabilities are settled, and any residual proceeds are paid to shareholders in priority order. Liquidation can be triggered by insolvency, by a shareholder resolution to dissolve, or as the cash-distribution event in an acquisition or wind-down.
Types of liquidation
- Voluntary liquidation: initiated by shareholders or directors, typically when the business is no longer viable but solvent enough to pay creditors in full. Common at startup wind-downs.
- Insolvent liquidation: assets are insufficient to pay creditors. Triggered by court process or creditor petition. Governed by national insolvency law: UK Insolvency Act 1986, US Bankruptcy Code, Türkiye İcra İflas Kanunu.
- Deemed liquidation in M&A: venture charters usually treat a merger or sale of the company as a deemed liquidation event, so sale proceeds are distributed per the preference waterfall.
The liquidation waterfall
Proceeds are distributed in a strict order: the “waterfall”:
- Secured creditors: banks with collateral on specific assets.
- Statutory preferential claims: wages owed to employees, certain taxes: varies by jurisdiction.
- Unsecured creditors: trade payables, unsecured loans, bondholders.
- Preferred shareholders: in order of liquidation preference seniority: either with later series ranking first (Series B before Series A) or pari passu, depending on the charter.
- Common shareholders: founders and employees with common stock: receive what is left, often nothing.
Liquidation preference for venture investors
The liquidation preference term in a preferred-stock investment specifies the multiple of capital that the investor receives before common shareholders see anything. A 1x preference returns invested capital first; 2x doubles it. Participating preferences let the investor take both the preference and a pro-rata share of remaining proceeds: particularly painful for common in low-exit scenarios.
Implications for founders
Founders’ common stock sits at the bottom of the waterfall. In a down-side exit where the company sells for less than the total liquidation preferences, founders receive nothing despite their nominal ownership percentage. Modelling the waterfall at every term sheet is critical to understanding founder economics at various exit scenarios.
Do: model the post-financing waterfall at every term sheet, including 1x and 2x preferences, participating vs. non-participating, and the actual founder payout at low/medium/high exit values.
Don’t: accept liquidation preferences above 1x non-participating without understanding the founder-economics impact: these terms compound across rounds and can leave founders with nothing on an otherwise “successful” exit.
For the Turkish procedure, including voluntary liquidation under the Commercial Code, bankruptcy and composition (konkordato), see liquidation and bankruptcy of a Turkish company.
Our analysis on this topic
- ›Who Gets Paid First at Exit: Liquidation Preference and Anti-Dilution
- ›Privileged Shares in a Turkish Joint-Stock Company: How Liquidation Preference and Investor Vetoes Are Actually Built
- ›Minimum Capital Deadline Extended to 31 December 2027: What Turkish A.Ş. and Limited Companies Must Do (TCC Provisional Art. 15)