In my post, Preferred Stock:  Participation, I mentioned the concept that when a company is sold there is a hierarchy that determines the order in which parties get paid.  Typically the first group to get paid is the lenders, often followed by equity holders.  Within the equity holders there can also be a hierarchy; determining which types of equity holders get paid first.  Preferred stock typically includes a liquidity preference that is paid before common stock.

In most scenarios, the liquidity preference gives preferred stock holders the right to get paid out a fixed amount - usually a multiple of their total dollars invested - before common stock is paid.  For example, if an investor has a 1-times liquidity preference they will get their that money back before capital is allocated to the common pool.

It is important to note that liquidity preference is in addition to participation.  As a result, investors get a multiple of their money back and then have rights to their percentage of the payout to common stockholders. 

I will address why this structure is used in my next post.