Question & Answer
How Do I Structure a Deal to Ensure I Get Paid Before Other Investors?
Not all investors are equal when it comes to payouts. When a company exits or liquidates, the order in which investors get paid depends entirely on how the deal was structured. Sophisticated investors don’t leave this to chance – they negotiate terms that ensure they receive their capital back before others see a return.
Using Liquidation Preferences for Priority Payouts
The most direct way to secure priority in payments is through liquidation preferences. These clauses define who gets paid first and how much they receive before common shareholders or lower-ranking investors.
Common liquidation preference structures include:
- 1x Liquidation Preference – The investor gets their original investment back before common shareholders receive anything.
- Participating Preferred – After receiving their investment back, the investor also participates in any remaining equity distribution.
- Multiple Liquidation Preferences – Some investors negotiate 2x or even 3x liquidation preferences, ensuring they receive two or three times their original investment before common shareholders see returns.
Securing Seniority in Capital Stack
In deals involving multiple investors, capital stack positioning matters. Investors who hold senior preferred shares get paid before those with standard preferred shares or common stock.
Ways to structure seniority include:
- Senior Preferred Shares – A higher-ranking class of preferred stock that gets paid first.
- Secured Debt – Lending capital instead of investing in equity ensures repayment before any shareholder distributions.
- Convertible Notes with Priority – Debt that converts to equity at a later stage but maintains repayment priority if the company exits early.
By positioning yourself at the top of the capital structure, you ensure your payout comes before lower-priority investors.
Structuring Debt for Guaranteed Returns
Equity investments offer upside but no guarantees. If ensuring payout priority is the main objective, debt structures offer a better alternative.
Options include:
- Secured Loans – Debt backed by company assets or intellectual property, ensuring repayment even in liquidation.
- Revenue-Based Financing – Instead of waiting for an exit, investors receive a percentage of revenue until a pre-agreed return is met.
- Convertible Debt with Interest – The investor receives interest payments and can convert to equity if the company performs well.
Debt-based structures provide financial security while still offering an opportunity for upside if equity conversion is included.
Example: Securing Priority in a Deal
Imagine two investors each put $5M into a company. Investor A secures a 1.5x liquidation preference and a senior preferred share class, while Investor B takes standard preferred shares.
If the company exits for $20M, the payout order looks like this:
- Investor A receives $7.5M (1.5x their original investment).
- Investor B receives $5M.
- The remaining $7.5M is distributed among common shareholders.
Because Investor A negotiated priority terms, they received a larger payout before other investors saw any returns.
Deal structuring isn’t just about valuation – it’s about securing financial protection. By leveraging liquidation preferences, seniority in the capital stack, and debt-based investments, investors can ensure they get paid first in any liquidity event.
In Deal Structuring, I explore examples of how investors have successfully positioned themselves for priority payouts.
Deal Structuring
Buy the book today and dive into practical techniques that empower you to get started immediately, navigating transactions efficiently and maximizing your success in minimizing cash requirements.
In this book, you will:
- Be introduced to the fundamentals of deal structuring
- Learn 19 proven deal models for structuring deals
- Discover 39 key elements of deal nuances
- Access 32 actionable clauses for your term sheets
- Explore 9 specific deal structures
- Receive 257 pages of invaluable insights
- Gain the distilled expertise of 20 years