October 23, 2026
If the sale price is less than the total liquidation preference, the preferred stockholders take everything and the common stock, including founders and option holders, receives nothing. Deals still get done in that zone because buyers need the team and investors need the deal to close, so the money for founders and employees comes from three places: a management carve-out plan that investors agree to fund off the top, retention packages the buyer pays on top of the price, and sometimes an investor waiver of part of the preference. The board has to run this process carefully, because its duty runs to the common stockholders even when the preferred control the vote.
Key takeaways
Start with the equity value, meaning the price after debt, transaction expenses and any working capital shortfall. Then add up the liquidation preferences of every series of preferred stock. With the standard 1x non-participating preference, each series takes back what it paid or converts to common and shares pro rata, whichever is more. If the equity value is below the total preference, no series will convert and the common gets nothing. See Liquidation Preference.
Example. The company has 9,000,000 fully diluted shares. Founders hold 4,000,000 shares of common, employees hold 1,000,000 options with a $0.20 exercise price, Seed investors hold 1,500,000 shares of preferred for which they paid $2,000,000, and Series A investors hold 2,500,000 shares of preferred for which they paid $10,000,000. Both series have a 1x non-participating preference, and the Series A is senior to the Seed. The preference stack is $12,000,000.
A buyer offers $10,000,000 of equity value. Converting would give the Series A 2,500,000 of 9,000,000 shares, or about $2,780,000, so it takes its $10,000,000 preference instead. That is the whole price. Seed gets nothing and common gets nothing. If the two series were pari passu rather than senior and junior, they would split the $10,000,000 in proportion to their preferences, about $8,330,000 to the Series A and $1,670,000 to the Seed, and common would still get nothing.
Now raise the price to $18,000,000. Neither series converts, because converting still pays less than the preference, so the preferred take $12,000,000 and the remaining $6,000,000 goes to the common and the options. Adding back the $200,000 of option exercise prices and dividing by 5,000,000 shares gives $1.24 per share. Founders receive $4,960,000 and option holders $1,040,000 net of their exercise price. The founders hold 44% of the company and receive 28% of the equity value. In this cap table the Seed doesn't convert until the price passes about $18,500,000 and the Series A doesn't convert until about $36,000,000, so founders' share of the total price stays below their 44% ownership all the way through that range.
Build this model before you talk to a buyer, and run it at the three prices you think are plausible. The difference between $10,000,000 and $18,000,000 is the difference between zero and nearly $5,000,000 for the founders.
A management carve-out plan, sometimes called a management incentive plan or sale bonus plan, sets aside a percentage of the sale proceeds for a named group of employees, paid before the liquidation preferences. The percentage is commonly 5% to 10% of net proceeds, higher in a very small deal, and it is allocated among participants by the board, usually weighted toward the founders and the people the buyer most needs. Payment is typically conditioned on staying through closing, and the plan is treated as a transaction expense, so it comes off the top and reduces what the preferred receive.
In the $10,000,000 example, a 10% carve-out pays $1,000,000 to the plan participants and $9,000,000 to the preferred. The investors fund the carve-out from their own recovery, which is why it needs their consent. The company's charter and investor agreements usually require preferred approval for anything that changes how proceeds are distributed, and the plan should be approved by the board and the required preferred holders in writing before the deal is signed.
Carve-out payments are compensation to the recipients, not sale proceeds, so they are subject to withholding and payroll taxes, they can count toward the golden parachute limits under Section 280G, and a plan that pays out after closing needs to be drafted with the deferred compensation rules in mind. Have a tax advisor review the plan before it is adopted.
A buyer that needs the team will pay for it. Retention packages are cash bonuses or new equity paid over one to three years after closing to employees who stay, and they come from the buyer's budget rather than the purchase price, so investors have no claim on them. In an underwater deal the retention package is often worth more to the founders than the carve-out. Ask the buyer early how much it has set aside for retention, who is on the list and what the vesting looks like, and make sure the LOI says whether retention is inside or on top of the price. See How Do I Read an Acquisition LOI? and What Happens to My Employees in an Acquisition?
There is a line to watch. If the price is low and the retention is unusually rich, investors may argue that purchase price has been relabeled as compensation to route money around the preference. The buyer has the same worry in reverse, because it wants to deduct compensation and it doesn't want employees to walk after closing. Keep the retention terms at market and tied to real continued service.
Sometimes. An investor facing a choice between a small recovery now and a wind-down later may agree to convert to common, to cap its recovery or to give the common a fixed percentage of proceeds so that the team has a reason to close. Later-stage investors who paid the highest price are usually the most reluctant, since their preference is the one being waived. Make the case with numbers: show what the preferred receive with and without the team's cooperation, and what they receive if the company shuts down instead. A waiver requires the consent of the affected series under the charter and is documented in the merger agreement or a separate waiver.
Delaware law puts the board's duty on the side of the common stockholders as the residual owners of the company, and that duty doesn't change because the preferred control the board or the vote. When a board dominated by investor-appointed directors approves a sale in which the preferred take everything and the common take nothing, Delaware courts have applied their most demanding standard of review, entire fairness, which asks whether both the process and the price were fair to the common. In the leading case the directors escaped liability even though the court found the process unfair, because the common had no value outside the sale. Directors shouldn't count on that result. A record showing the board considered the common's interests, weighed the alternatives and reached a fair price is what wins these cases.
In practice that means four things. First, the board should consider the alternative to selling, including continuing to operate, raising a bridge or recapitalizing, and record why the sale is better for the common. Second, directors affiliated with the preferred should disclose the conflict, and where the board has disinterested directors they should lead the process or form a committee. Delaware's 2025 amendments to Section 144 give a safe harbor for conflicted transactions approved, with the material facts disclosed, by a majority of the disinterested directors (or a committee of at least two disinterested directors) or by a majority of the votes cast by disinterested stockholders. Transactions with a controlling stockholder must meet stricter versions of these conditions. Third, the minutes should show the carve-out plan and any retention arrangements were considered as part of the fairness of the deal to the common. Fourth, get the right approvals: a merger needs a majority of the outstanding stock, the charter may require separate class votes, and your drag-along should be checked to see who it binds. Westaway's recommended drag-along trigger is the board plus a majority of the preferred plus a majority of the common, so founders generally keep a vote. See Fiduciary Duties of Startup Founders and Drag-Along Rights.
If the common receives nothing, options are worth nothing, and the merger agreement usually cancels them at closing for no payment. Employees should hear that from you before they hear it from the buyer. The buyer's retention packages and new grants in the buyer's equity are what replace them, which is one more reason to negotiate those packages hard. See What Happens to Stock Options When a Startup Is Acquired?
For more, see Founder Guide: Selling Your Startup, Startup Acquisitions: The 3 Types of Deals and How a Sale Works, Preferred Stock vs Common Stock, What Is a Down Round in Startup Funding? and Being Acquihired.
If you're weighing an offer that sits below your preference stack, contact us before the board meets.
