THE OUTLAW CHRONICLES. Issue #4
MISSION BRIEFING
Vegi raised $14M across three rounds. The company sold for $20M. By the time the preference stack cleared, she walked away with just over $1M. Reti's fund collected $11.2M. This issue is about how that arithmetic works and how to see it before you sign.
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VENTURE ODYSSEY
Departure: The Round That Felt Like Winning
The term sheet arrived on a Tuesday. Vegi remembered because she was eating a late lunch at her desk on the Vega system's main orbital platform and nearly knocked the tray off the table when the notification came in.
Series B. $8 million. Post-money valuation of $40 million.
She had been building for four years. Revenue was real. The team was small but good. The product did exactly what it was supposed to do. And now an investor from Zeta Reticuli, one of the most respected funds in the quadrant, wanted to lead the round.
Vegi called her co-founder. She called her mum. She sent a message to the group chat that just said "IT'S HAPPENING" in all capitals.
She did not call a lawyer that day.
The term sheet had a section called "Liquidation Preference." One clause, three sentences. Reti's team had kept it tight. Professional. The number was 1x. Vegi knew that meant one times the investment back before anyone else got paid in an exit scenario. She had heard this was standard. Her previous investors, the angels from the Seed round and the lead from Series A, had the same clause. It seemed fine.
(Here is the thing about "standard" in term sheets. Standard just means common. It does not mean harmless.)
The lawyers turned the term sheet into documents over the following six weeks. Vegi reviewed them carefully. She asked about the things she understood. She did not know what she did not know. Nobody does, until later. That is the whole architecture of the problem.
The documents were signed. The $8M landed. Vegi went back to building.
She did not think about the liquidation preference clause again for three years.
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Layover: The Number That Came Back
The acquisition conversation started quietly. A strategic buyer from a neighbouring system had been watching the company for eighteen months. They liked the product. They liked the team. They thought $20M was a fair price. Vegi thought $20M was a fair price too. It was 2x the last post-money valuation. That felt like a win.
She called me from a noisy cafe somewhere on the orbital platform. I was in Barcelona, sitting on my terrace. It was early evening here, mid-afternoon there.
"We've got an offer," she said. "Twenty million. I think we should take it."
"Who's in the cap table?" I asked.
She listed them. Seed angels with $800K in total. Series A, $5.2M at $14M post. Series B, which was Reti's fund, $8M at $40M post.
I asked about the preference terms.
"They're all 1x," she said. "Non-participating. Standard."
"Send me the documents," I said.
She sent them in ten minutes. I read them in twenty.
Then I called her back.
"Vegi," I said. "I need you to sit down."
Here is what the preference stack actually looked like.
Liquidation preference is the right of investors to get their money back first, before founders or employees, in any exit, sale, or liquidation. Every investor in every round had a 1x non-participating liquidation preference. That sounds symmetrical and harmless. It is neither.
Non-participating means the investors collect their preference and then step aside. They do not share in the remaining proceeds. This is the better version of the clause. Participating preferred would have been worse. So non-participating is good. Remember that.
But stack the preferences and the math changes.
Reti's fund put in $8M at Series B. Preference: $8M first. Paid before anyone else sees a cent.
Series A put in $5.2M. Preference: $5.2M second. Paid after Reti, before anyone else.
Seed angels put in $800K. Preference: $800K third. Paid after Series A.
Total preference stack: $14M. This amount comes off the top of any exit, in order, before common shareholders see anything.
$20M exit, minus $14M preferences, leaves $6M.
That $6M gets distributed to common shareholders by ownership percentage. Vegi owned 17% of the common. Her co-founder owned 14%. The option pool represented 28% of the common.
Vegi's 17% of $6M is $1.02M.
But wait.
Investors with non-participating preferred choose whether to take the preference or convert to common and share in the full proceeds. Rational investors take whichever is higher.
Reti's fund owned 22% of the company. 22% of $20M is $4.4M. The preference produces $8M. Reti takes the preference.
Series A owned 19%. 19% of $20M is $3.8M. The preference produces $5.2M. Series A takes the preference.
Seed angels owned 8%. 8% of $20M is $1.6M. The preference produces $800K. The angels convert to common and take $1.6M instead.
So Reti: $8M. Series A: $5.2M. Angels (converted): roughly $544K. Remaining common pool: approximately $6.2M. Vegi's 17%: $1.054M.
She had modelled $3.4M. She had been planning on $3.4M.
I told her the real number.
There was a pause that lasted about eight seconds.
"That can't be right," she said.
"I'm looking at the documents," I said.
Another pause.
"Tell me what I'm missing."
"You're not missing anything," I said. "The documents are working exactly as written. Reti gets paid first. Series A gets paid second. You and your team get what's left."
She was quiet for a moment. I could hear the cafe in the background. Someone ordering something. A chair scraping.
"I raised fourteen million," she said, finally. "And I'm walking away with one."
"Just over one," I said. "Yes."
She did not say anything for a while.
Arrival: What the Structure Was Always Saying
The deal closed. Vegi's co-founder got $877K. The employees with vested options got varying amounts, most of them less than they had been expecting. Reti's fund returned 1.4x to their LPs and called it a portfolio exit. The press release said both parties were "delighted."
Liquidation preferences are not a punishment. They are not malicious. They are a rational demand from investors writing a cheque without knowing how things turn out. If the company fails, the preference protects some of their money. If the company does moderately well, the preference means they get their capital back before founders profit. This is reasonable.
But a stack of 1x preferences compounds. Each new round adds a new floor. The floor rises. The range of outcomes in which founders see meaningful money narrows. This is not a bug. It is a feature of the structure that investors understand completely and founders often do not, until they do.
Think of it like buying a house with three mortgages from three banks. All three banks must be paid in full before you see any equity. The house sells. The banks take their share in order of seniority. What you actually own is the remainder. If you borrowed 70% of the sale price in total mortgages, you walk away with 30% of the proceeds. This is obvious when the mortgage is a mortgage. It is less obvious when the mortgage is called a liquidation preference.
Vegi knew about liquidation preferences. She had read about them. What she had not done was model her specific stack at different exit values before signing each subsequent round.
That is the practical observation: the preference stack needs to be modelled at every round, not just read. Pull out a spreadsheet. Plug in the new investment. Plug in three exit scenarios: 1x, 2x, 3x your latest post-money valuation. Calculate what each class of shareholder receives. If the founder number at 2x post-money is smaller than you expected, you now have that information before you sign, not after.
Vegi is building again. She knows more now. That is worth something, even if it cost more than she expected to learn it.
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THE BLUEPRINT
Five things to do before your next funding round closes.
Build an exit waterfall for three scenarios. Take your post-money valuation from this round. Model what each shareholder class receives at 1x, 2x, and 3x. If the founder column at 2x looks thin, you are seeing your structure clearly for the first time. Do this before you sign, not after.
Ask about participation rights explicitly. Non-participating means investors take their preference OR convert to common. Participating means they take the preference AND share in the remainder. Participating is worse for founders. Ask which type each investor has. Ask why.
Understand the conversion calculation at each exit price. Non-participating investors convert to common if common beats their preference. Model the conversion threshold for each investor class. Below that price, they take the preference. Above it, they convert. Knowing where each investor's conversion point sits tells you which exit scenarios actually benefit founders.
Check whether your preference terms compound or stack. Some deals have participating preferred that also accrues interest. These are preferences that grow over time. If you have these in your documents, model the preference amount at year 3, 4, and 5, not just at signing.
Negotiate on participation terms at your most valuable moment. The moment you have the most leverage is before the term sheet is signed. After signing, terms are largely fixed. The conversation about participating vs. non-participating preferred is a legitimate negotiation point. Investors who push for participating preferred in an otherwise standard round are telling you something about how they model exits. Listen.
Free resource: Exit Waterfall Calculator (Google Sheet). Plug in your cap table, preference terms, and an exit price. The sheet distributes proceeds in order and shows what each class receives. Download here: https://mexzungu.com/resources/exit-waterfall-calculator
CURIOUS CORNER
Three things from the cosmos this week.
NVCA Model Term Sheet (2025 edition): The National Venture Capital Association publishes the template term sheet most US VC deals are based on. The liquidation preference section is on page 4. If you have never read the actual model language, this is where "standard" comes from. https://nvca.org/model-legal-documents/
Y Combinator's Plain English Guide to Term Sheets: YC published a guide that walks through term sheet clauses in non-lawyer language. The liquidation preference section is particularly good on the participating vs. non-participating distinction. Written for founders who have never seen one of these before and need to understand it in 20 minutes. https://www.ycombinator.com/library/7j-term-sheet-guide
Carta 2025 State of Private Markets Report: Carta's annual dataset covers exit distributions across thousands of VC-backed companies. The data on founder returns at different exit multiples is sobering. The median exit multiple at which founders start seeing meaningful common stock returns is higher than most people expect. https://carta.com/blog/state-of-private-markets-2025/
THE QUESTION
I want to know about the moment you first modelled your own exit waterfall. Not read about it. Actually sat down, opened a spreadsheet, plugged in the numbers for your specific cap table, and saw what you would actually walk away with. Was it before you signed a round, or after? And if it was after, what did you see?
SIGN-OFF
Writing this from my Barcelona terrace at an hour that is arguably too late but the city is still making noise outside so it feels fine. Next issue: we are going inside the vesting schedule, and there is one word in there that can take four years of work off the table in a single board meeting. Read that sentence again before you sign anything. Now go build something the preference stack does not get to touch.
Pepe
DISCLAIMER
The Outlaw Chronicles is for education only. Nothing here is legal advice. For the real thing, you know where to find me.
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