A participating preference is a type of investor right that allows preferred shareholders to receive their initial investment back first, and then also participate in sharing the remaining proceeds with common shareholders.
When your company is sold or pays dividends, participating preference holders get paid twice.
First, they receive their original investment amount before anyone else gets paid.
Then, they also get a share of whatever money remains, just like ordinary shareholders would.
Non-participating preference means investors choose either to get their money back first OR to share in the remaining proceeds - but not both.
Participating preference lets them do both, which obviously gives them a much larger slice of any exit proceeds.
Participating preference protects investors from disappointing exits whilst still letting them benefit from successful ones.
If your company sells for exactly what they invested, they get their money back.
If it sells for much more, they get their investment back plus extra returns.
Participating preference significantly reduces what founders and employees receive from company exits.
Since investors get paid twice, there's much less money left over for equity holders who don't have these special rights.
Yes, participating preference terms are definitely negotiable, especially if you have multiple interested investors.
You might negotiate for caps on participation, shorter time limits, or conversion to non-participating preference under certain conditions.
Be particularly careful with participating preference in early funding rounds, as these terms typically carry forward to future investment rounds.
Multiple layers of participating preference can leave very little for founders even in successful exits.
