A participation cap restrains participating preferred stock: after the holder takes its liquidation preference and then shares in the remaining proceeds, total recovery is capped at a multiple (e.g., 3x) of the amount invested. Beyond that point the holder is better off converting to common.
The cap balances downside protection for investors against fairness to founders and common holders in larger exits. Negotiating the cap multiple — or eliminating participation in favor of non-participating preferred — is a central economic point in term-sheet talks.