The waterfall
When a company sells, the money flows down a fixed order. Learn the order, do the math for a small, a medium, and a large sale, and see why your ownership is not your payout.
In this lesson you will learn
- The order in which a sale pays debt, preferred stock, and common stock
- How to calculate the payout to each holder in a sale, step by step
- Why founders get less than their ownership in small and medium sales
- How seniority and participation change the payout to the founders
Ada and Ben own 46% of Northwind. A buyer pays $120M for the company. Ada and Ben get 41% of the money. Where did the rest go? The answer is the waterfall: the order and the math that divide the money from a sale.
Why there is an order of payment
Investors do not buy the same shares as the founders. They buy preferred stock, and founders and employees hold common stock. The most important right of preferred stock is the liquidation preference. In a sale or a shutdown, the preferred holders get their money back before the common holders get a dollar.
Investors ask for this right for a reason. They pay a high price for each share, often many times what the founders paid. Without a preference, the founders can sell the company soon after a round, for less than the investors paid, and keep most of the money. The preference protects the investors against that sale.
Each round adds its preference to the preference stack. The lesson on liquidation preferences shows each type of preference with one investor. This lesson puts all the series together.
Northwind at its sale
Northwind raised three rounds. Every series is 1x non-participating preferred, the standard term:
| Holder | Security | Shares | Price for each share | Preference | Ownership |
|---|---|---|---|---|---|
| Founders (Ada and Ben) | Common | 6,000,000 | none | none | 46.15% |
| Employees | Common (exercised) | 1,000,000 | none | none | 7.69% |
| Seed | Series Seed preferred | 2,000,000 | $1.00 | $2M | 15.38% |
| Series A | Series A preferred | 2,000,000 | $5.00 | $10M | 15.38% |
| Series B | Series B preferred | 2,000,000 | $15.00 | $30M | 15.38% |
| Total | 13,000,000 | $42M | 100% |
The Series B is senior: it gets its money before the other series. The Seed and the Series A are pari passu: they have equal rank and share a shortfall in proportion to their preferences. The Series B post-money valuation was 13,000,000 × $15 = $195M.
Predict first
Northwind sells for $36M. The founders own 46.15%. How much do the founders get?
Type a guess before you continue. A guess first, even a wrong one, makes the answer easier to remember.
The founders get $0. The preference stack is $42M, more than the $36M price. The Series B gets its $30M first. The Seed and the Series A share the last $6M. Nothing is left for common stock. Ownership percentages apply only after the company pays the preferences.
The procedure
Every waterfall uses the same steps:
- Start with the net proceeds: the price minus debt, fees, and the escrow and earnout that are not paid yet.
- Pay the preferences in the order of seniority. If a group of equal rank cannot get all its preferences, divide the money in proportion to the preferences.
- Divide the rest among the common shares and the preferred shares that convert, in proportion to shares.
- For each non-participating series, compare its two choices: keep the preference, or convert to common and get its share of step 3.
- If a series gets more with the other choice, change its choice and calculate again. Stop when no series wants to change.
Step 4 is the important one. A non-participating series gets the larger of its preference or its as-converted share. It never gets the two together.
A small sale: $36M
The price is less than the $42M stack. The preferences get all of it:
Series B (senior) $30.0M its full preference
Money that stays $6.0M
Seed: 2/12 × $6M $1.0M pari passu with Series A
Series A: 10/12 × $6M $5.0M
Common stock $0
Does a series get more if it converts? No. If every series converts, one common share gets $36M ÷ 13M = $2.77. The Series B paid $15.00 for each share and the Series A paid $5.00, so each keeps its preference. The Seed gets $2.77 for each share as common only if the other two series also convert, and they do not.
A medium sale: $120M
This is the sale in the first paragraph of this lesson. Do it one step at a time.
Worked example · step 1 of 5
Northwind sells for $120M
- 1
Try "every series converts"
Divide the price by all shares. As common, the Series B gets less than the $15.00 it paid for each share, so it keeps its preference.
$120M ÷ 13M shares = $9.23 a share Series B as common = 2M × $9.23 = $18.5M (less than $30M)
The founders own 46.15% but get 40.91%. The cause is the Series B. As common, it gets only 15.38% of $120M, or $18.5M. With its preference, it gets $30M. The other $11.5M comes from every holder who converts, the founders too.
Now try other sale prices. The table shows which series keep their preference and which convert. The chart shows each holder’s payout at every price.
Simulator
Who gets what when Northwind sells
Move the sale price. Watch which investors get their preference, which convert, and what stays for the founders.
- Founders get
- $49.09M
- 40.91% of the money
- Founders own
- 46.15%
- of all shares
- Per common share
- $8.1818
- Preference stack
- $42M
- paid before common
Who gets the $120M
- Founders
- Employees
- Seed
- Series A
- Series B
| Holder | Owns | Choice | Gets | Share of the money |
|---|---|---|---|---|
| Founders | 46.15% | Common | $49.09M | 40.91% |
| Employees | 7.69% | Common | $8.18M | 6.82% |
| Seed | 15.38% | Converts | $16.36M | 13.64% |
| Series A | 15.38% | Converts | $16.36M | 13.64% |
| Series B | 15.38% | Preference | $30M | 25% |
| Total | 100% | $120M | 100% |
- Founders
- Employees
- Seed
- Series A
- Series B
The Series B keeps its preference, because conversion pays less. The Seed and the Series A convert to common. Each common share gets $8.1818.
The founders own 46.15% but get 40.91% of the money: $49.09M of $120M.
The next change comes at $195M, where the Series B converts.
Change the cap table
Move the slider slowly from $10M to $300M and watch the founders’ line. It stays at zero until $42M. Then it bends three times, at $49M, $85M, and $195M. At each bend, one more series converts.
A large sale: $400M
When the price is high, every series converts. Each common share gets the same amount, and each holder gets exactly its ownership:
Each share $400M ÷ 13M = $30.77
Series B 2M × $30.77 = $61.54M (more than its $30M preference)
Founders 6M × $30.77 = $184.62M (46.15% of $400M)
The map of a waterfall
The founders’ payout is a line with bends. Each bend is a breakpoint, where the preferences become fully paid or where one series changes its choice. The last column is the most useful one. It shows what part of each added dollar goes to the founders:
| Sale price | What occurs | Founders get of each added $1 |
|---|---|---|
| $0 to $30M | The Series B gets everything | $0 |
| $30M to $42M | The Seed and the Series A share what stays | $0 |
| $42M to $49M | All preferences are paid. 7M common shares share the rest | 85.7 cents |
| $49M to $85M | The Seed converts. 9M shares share the rest | 66.7 cents |
| $85M to $195M | The Series A converts. 11M shares share the rest | 54.5 cents |
| $195M and more | The Series B converts. All 13M shares share | 46.2 cents |
Work it out
Northwind sells for $60M. How much do the founders get?
The Series B keeps its $30M, because $60M ÷ 13M = $4.62 is less than $15.00. If the Seed and the Series A convert, 11M shares share $30M: $2.73 each. That is less than the $5.00 that the Series A paid, so the Series A keeps its $10M. Now $20M stays. If the Seed converts, 9M shares share it: $2.22 each, more than $1.00. So the Seed converts. The founders get 6M × $2.2222 = $13.33M.
Work it out
Northwind sells for $200M. How much do the founders get?
$200M is more than $195M, the Series B post-money valuation. Thus every series converts: $200M ÷ 13M = $15.38 a share, more than the $15.00 that the Series B paid. The founders get 6M × $15.38 = $92.31M, exactly 46.15% of the price.
Seniority decides the small sales
Seniority sets the order of payment when the money is not sufficient for all preferences. There are two usual structures:
- Stacked: the newest series gets its money first, then the series before it, and so on down to the seed.
- Pari passu: all series share the money in proportion to their preferences.
Northwind’s terms mix the two: the Series B first, then the Seed and the Series A equally. Compare three structures in the $36M sale:
| Structure | Series B | Series A | Seed | Founders |
|---|---|---|---|---|
| Series B first, then the rest equally | $30M | $5M | $1M | $0 |
| Stacked: each newer series first | $30M | $6M | $0 | $0 |
| Pari passu: all equally (36/42 of each preference) | $25.71M | $8.57M | $1.71M | $0 |
Thus seniority changes how the investors divide a small sale. Above the stack, seniority makes no difference, because every preference is paid in full. In the widget, change the seniority and move the price to less than $42M.
Participation changes every sale above the stack
With participating preferred, a series gets its preference and then also its share of what stays. Founders call it the “double dip”. Select “Full” for the Series B in the widget, and compare the $120M sale:
Series B preference $30.00M
Series B share of the rest 2M × ($90M ÷ 13M) = $13.85M
Series B total $43.85M (non-participating: $30.00M)
Founders 6M × $6.9231 = $41.54M (non-participating: $49.09M)
The founders get $7.55M less. In a $400M sale, they get $13.85M less, because a participating series with no cap never converts. Thus the founders pay 46.15% of the $30M preference at every price of $195M or more. Below $42M, participation changes nothing for the founders, because the preferences get all the money.
A participation cap limits the double dip. With a 3x cap, the Series B total stops at $90M. That occurs at a $420M sale. Above $585M, the Series B gets more if it converts, so it converts.
What real waterfalls add
Real sales add a few steps that this lesson does not show:
- Debt, banker fees, and lawyer fees come off the price first.
- A management carve-out can come before the preferences. The lesson on down rounds and recaps shows how.
- Employees with options get the common share value minus the exercise price of each option.
- Some charters add declared and unpaid dividends to the preference.
The merger agreement and the company’s charter set the exact rules. Read them, and ask the company’s lawyer to show you the waterfall for each offer that you get.
Quiz · question 1 of 5
Test what you learned
Northwind sells for $120M. What does the Series B do?
Key takeaways
- 1.The waterfall pays debt and fees first, then the preferred holders in the order of seniority, then the common holders.
- 2.A non-participating series gets the larger of its preference or its as-converted share, never the two together.
- 3.Founders get their full ownership percentage only when the sale price is more than the last post-money valuation, because then every series converts.
- 4.Seniority decides who gets paid when the money is not sufficient for all preferences. Participation takes money from the common holders at every sale price above the stack.
Sources
- 1.Q2 2026 Venture Financing Report. Cooley, August 17, 2026.
- 2.2026 WilmerHale Venture Capital Report. WilmerHale, April 2026.
- 3.NVCA Model Certificate of Incorporation. National Venture Capital Association, October 2025.