Here's the argument I've heard: Let's say you found a company. A VC invests $1M for 20% of the company, for a $5M post-money valuation. Then you immediately sell the company for $3M (less than $5M). You make $2.4M. The VC essentially loses $400k. The 1x liquidation preference protects them from losing that $400k.
It's also worth pointing out that >1x liquidation preferences make a similar type of sense: if the VC invests $1MM for a post-money valuation of $5MM, and is handed the $1MM back two days later while the owner pockets $2MM, that's not really respectful of their time. It would probably be okay to limit the liquidation preferences at 1x and rely on professionalism, but higher multiples aren't an outrageous ask most of the time (the investor and the founder(s) should have similar outlooks for the future of the company) and it's a pretty easy thing to put in during negotiation.
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Here's the argument I've heard: Let's say you found a company. A VC invests $1M for 20% of the company, for a $5M post-money valuation. Then you immediately sell the company for $3M (less than $5M). You make $2.4M. The VC essentially loses $400k. The 1x liquidation preference protects them from losing that $400k.
It's also worth pointing out that >1x liquidation preferences make a similar type of sense: if the VC invests $1MM for a post-money valuation of $5MM, and is handed the $1MM back two days later while the owner pockets $2MM, that's not really respectful of their time. It would probably be okay to limit the liquidation preferences at 1x and rely on professionalism, but higher multiples aren't an outrageous ask most of the time (the investor and the founder(s) should have similar outlooks for the future of the company) and it's a pretty easy thing to put in during negotiation.