Fundraising

Participating vs Non-Participating Preferred Stock - What the Numbers Mean at Exit

One term sheet clause can cut your founder payout in half. Here is how to spot it and what to do about it.

May 8, 2026 - 8 min read

The Clause That Moves Millions

I watch founders close a funding round and zero in on the valuation number. They should be focused on two words buried in the liquidation preference section: participating or non-participating.

This single choice determines whether your investor gets paid once at exit or twice. And in a $30 million acquisition, the difference can be over $2 million landing in their pocket instead of yours.

That is the math on a standard deal structure, and I see first-time founders miss it until the wire hits.

What Preferred Stock Is

When a VC invests in your startup, they almost never buy common stock. They buy preferred stock - a separate class of equity that comes with specific rights common shareholders do not have.

Preferred shareholders get paid before common shareholders in a sale or liquidation. They also get to convert their preferred shares into common shares if that is worth more. These protections make investing in risky startups more palatable for institutional capital.

But not all preferred stock works the same way. The two main flavors are participating and non-participating, and they produce very different outcomes for founders and employees.

Non-Participating Preferred - The Either/Or Structure

Non-participating preferred gives the investor a choice when the company is sold. They can either take their liquidation preference back - typically 1x their original investment - or convert to common stock and take their pro-rata share of the total exit price. They pick whichever is bigger.

If the exit is modest, they take their money back. If the exit is a home run, they convert to common and ride the upside alongside founders.

This is the market standard today. According to Carta data, approximately 70% of all tracked Series A deals use a 1x non-participating liquidation preference. Cooley reported that in a recent quarter, 95% of venture deals used a non-participating structure.

The NVCA model term sheet defaults to 1x non-participating preferred. That tells you everything about what is considered founder-friendly in the current market.

Participating Preferred - The And Structure

Participating preferred removes the investor choice. Instead of picking one or the other, they get both. First they collect their liquidation preference off the top. Then they stay in the distribution as if they had converted to common stock, collecting their pro-rata share of whatever is left.

This is the double-dip. The investor takes their investment back and then participates in the remaining proceeds. Founders and employees share only what is left after that second bite.

Participating preferred is sometimes called the and structure versus non-participating preferred which is the either/or structure. That framing makes it easy to remember. With participating preferred, investors take their preference AND their pro-rata share. With non-participating, they take their preference OR their pro-rata share - whichever is higher.

The Dollar Difference - A Real Scenario

Here is the same deal under both structures so the numbers are concrete.

Two startups. Same capital structure: founders own 80%, an investor owns 20% after a $3 million investment. Both companies sell for $30 million.

Under non-participating preferred: The investor sees that 20% of $30 million is $6 million - better than their $3 million preference - so they convert to common. They take $6 million. Founders split the remaining $24 million.

Under participating preferred: The investor takes their $3 million preference off the top first. That leaves $27 million. They then collect 20% of that $27 million as their participation share - another $5.4 million. Total investor payout: $8.4 million. Founders split the remaining $21.6 million.

Same exit. Same ownership percentage. Participating preferred moved $2.4 million from the founders to the investor on a $30 million deal. On a $10 million exit, the founders lose an even larger share of what they take home.

Founders Workbench ran a similar example with a $6 million liquidation preference on a $10 million sale. The difference between participating and non-participating was a $2 million shift in economics - exactly half of what management would have received under a non-participating structure. Founders walked away with half of what the structure appeared to promise them.

Where Participating Preferred Shows Up

Participating preferred has been falling out of favor in top-tier VC deals for years. Wilson Sonsini noted in their Entrepreneurs Report that participating preferred liquidation preferences seem to be falling out of favor even as other investor-friendly terms became more common in tighter markets.

Earlier data from Wilson Sonsini showed that about 81% of their deals used non-participating preferred structures. That number has only trended upward as competition among investors increased and founders became more sophisticated about term sheet economics.

But participating preferred still appears in specific situations. It shows up more often in later-stage rounds, particularly Series B and beyond. One legal report from the New England market found approximately 45% of Series A investments and roughly 60% of Series B and later rounds included some form of participation rights. It also surfaces in distressed or down-round situations, where investors use participation as downside protection. Smaller markets, non-institutional investors, and family offices are also more likely to ask for it.

The pattern is consistent: the more leverage the investor has, the more likely participation ends up on the term sheet.

Capped Participating Preferred - The Middle Ground

If an investor insists on participating preferred and you cannot get them off it, push for a cap. Capped participating preferred limits how much the investor can collect through the double-dip.

A 2x cap means the investor total return from both the liquidation preference and the participation cannot exceed two times their original investment. Once they hit that ceiling, remaining proceeds flow to common stockholders. Alternatively, investors can convert to common if that would pay them more than the capped amount.

So if an investor put in $1 million with a 2x cap, they collect at most $2 million through the preference-plus-participation structure, regardless of how large the exit is. That limits the damage to founders in mid-size exits while still giving the investor meaningful downside protection.

A capped structure is significantly better for founders than full uncapped participation. If you are negotiating and participating preferred is on the table, pushing for a 2x-3x cap is a realistic middle ground. Full participating preferred without any cap is considered the most investor-friendly version of the three structures.

What the Liquidation Stack Looks Like Across Rounds

One thing founders often miss: liquidation preferences stack. Every new round of preferred stock sits on top of the previous round in the payout waterfall, or shares proceeds pro-rata with earlier rounds depending on the deal structure.

The two common stack arrangements are last money in first money out - where later-round investors get paid first - and pari passu sharing, where all preferred shareholders split proceeds proportionally regardless of round. Your Series A terms will almost certainly influence what your Series B investors ask for. Participating preferred at the seed level often becomes a precedent that follows you through every subsequent round.

An investor who gets participating preferred at your seed round is setting the template for every future cap table negotiation.

How to Negotiate When You See Participating Preferred

First, model the scenarios. Build a simple waterfall spreadsheet and plug in your realistic exit scenarios - $10 million, $30 million, $50 million. Show yourself what participating versus non-participating means at each price point. The numbers make abstract terms concrete and give you a clear argument in the negotiation.

Second, push for non-participating as the default. This is the market standard at early-stage deals. If a sophisticated VC is asking for participating preferred in a competitive round, that is worth questioning. Ask what problem they are solving with it and whether a higher liquidation preference multiple on a non-participating structure would address that concern.

Third, if they will not move off participation, get a cap. A 2x cap is reasonable. Anything uncapped is the most damaging version for founders and employees.

Fourth, understand the whole stack before you sign. Do not evaluate liquidation preference in isolation. The valuation, the option pool, the board composition, and the participation structure all interact. A high valuation with participating preferred can still produce a worse outcome for founders than a lower valuation with non-participating preferred on a median exit.

Knowing how these terms play out under real exit scenarios matters more than knowing how to define them. If you want a second set of eyes from someone who has been on both sides of these tables, Learn about Galadon Gold - direct coaching from operators who have negotiated and closed exits.

The Conversion Trigger - When Non-Participating Investors Convert to Common

Non-participating investors do not always take their liquidation preference. They make a rational choice based on which payout is larger.

If an investor put in $5 million for 25% of the company and the company sells for $8 million, they take the liquidation preference - $5 million. Converting to common would only give them $2 million.

But if the same company sells for $40 million, they convert to common and take 25% - that is $10 million versus their $5 million preference. The preference becomes irrelevant in a big exit.

This is why non-participating preferred aligns investor and founder incentives reasonably well. On a big exit, the investor converts and both sides benefit proportionally. On a small exit, the investor gets their money back and founders get what is left. The structure creates a natural floor for investors without the double-dip ceiling on founder proceeds.

What This Means at the Seed Stage

In my experience, deals at the pre-seed and seed stage use SAFEs or convertible notes rather than priced preferred stock. But when seed rounds do price - and institutional seed rounds increasingly do - non-participating preferred is the overwhelming norm.

The danger at seed is setting bad precedents. Seed investors who take participating preferred, even with a small check, are creating a template. Series A investors will see that the company already accepted participation, and it becomes harder to negotiate away from it at scale.

If you are raising a priced seed round, push hard for non-participating preferred. It is much easier to maintain that standard than to walk it back in later rounds when there is more money and more weight on both sides.

One more thing worth knowing: the type of preferred stock you issue at each round should match your fundraising narrative. Sophisticated investors at Series A and beyond will read your entire cap table history. A clean non-participating structure from the start signals that you understood what you were agreeing to - and that you had the leverage to ask for it.

Frequently Asked Questions

What is the main difference between participating and non-participating preferred stock?

Non-participating preferred gives investors a choice at exit: take their liquidation preference back or convert to common stock and take their ownership percentage - whichever pays more. Participating preferred removes that choice and lets investors do both. They collect their liquidation preference first, then share in the remaining proceeds alongside common shareholders. This double-dip reduces what founders and employees receive.

Which structure is better for founders?

Non-participating preferred is better for founders. It is also the market standard at Series A. Carta data shows approximately 70% of tracked Series A deals use 1x non-participating preferred. Participating preferred reduces founder proceeds especially in modest to mid-size exits where the double-dip takes the largest relative bite.

What is capped participating preferred stock?

Capped participating preferred limits the total amount an investor can collect through the preference-plus-participation combination. For example, a 2x cap means the investor collects at most two times their original investment through both mechanisms combined. Once that ceiling is hit, remaining proceeds go to common shareholders. It is a middle ground between full participating preferred and non-participating preferred.

When does a non-participating preferred investor convert to common stock?

A non-participating preferred investor converts to common when their pro-rata ownership share of the total exit price exceeds their liquidation preference. On large exits, conversion pays more than the preference. On small or mid-size exits, they take the preference instead. The investor always picks whichever option pays them more.

Is participating preferred stock common in venture deals today?

It is becoming less common in early-stage institutional deals. Wilson Sonsini noted participating preferred seems to be falling out of favor. However it still appears in later-stage rounds, down rounds, and deals with non-institutional investors. Regional data shows it appearing in roughly 45-60% of Series B and later rounds in some markets.

What happens to liquidation preferences across multiple funding rounds?

Liquidation preferences stack. Each round of preferred stock adds another layer to the payout waterfall. Later-round investors are often paid first under a last money in first money out structure, though some deals use pari passu sharing where all preferred shareholders split proceeds proportionally. Participating preferred accepted in early rounds sets a precedent that can follow the company into every subsequent raise.

Can I negotiate away from participating preferred if an investor asks for it?

Yes, and you should try. The NVCA model term sheet defaults to non-participating preferred, which is the market standard you can point to. If an investor will not move off participation, push for a 2x-3x cap to limit the double-dip. Building a waterfall model showing exit scenarios under both structures makes your case better than any abstract argument.