Equity · Valuation

How exit proceeds actually get distributed, priced out across five exit values.

Debt, liquidation preferences, seniority, the conversion decision and what finally reaches common stock — one capital structure, fully worked.

Glide Research11 Aug 20269 min read

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In short

What is an exit waterfall?

An exit waterfall is the calculation that distributes the proceeds of a sale down the capital structure in order of priority: creditors first, then each preferred series by its liquidation preference and seniority, then common stock. It shows what every holder receives at any given exit price.

Also called waterfall analysis or a valuation waterfall

Key takeaways

Proceeds flow in strict order: transaction costs and debt, then liquidation preferences by seniority, then participation where it exists, then common stock last.
Preferred holders make a choice at every exit price — take the preference, or convert to common and take a percentage. A waterfall has to solve that choice, not assume it.
The conversion crossover for a 1× non-participating series is the exit value at which its ownership percentage is worth exactly its preference. It is different for every series.
Debt ranks ahead of all equity. Venture debt or a revenue loan outstanding at the exit comes off the top before any preference is paid.
The order of preferences matters when proceeds are short. Stacked seniority pays the newest series first; pari passu splits the shortfall proportionally.
A waterfall is not a single number. Run it across a range of exit values, because the ranking of outcomes changes as the price moves.
Underwater options do not get exercised, which concentrates proceeds among fewer common shares. A rigorous waterfall solves this iteratively rather than assuming full exercise.

The order of payment

When a company is acquired, the buyer pays a price and the company's own documents decide who gets what share of it. The rules live in the certificate of incorporation, the merger agreement and any loan documents. The sequence is always the same, even when the details are not.

How proceeds move down the structure

1. Transaction costs and escrow
Banker fees, legal fees and any holdback into escrow come out before anything is distributed. Escrow is normally released later, which means the waterfall runs twice.
2. Debt and other creditors
Venture debt, revenue loans, unpaid taxes and trade creditors rank ahead of every class of equity. A lender does not care what the equity story is.
3. Liquidation preferences, in seniority order
Each preferred series takes its multiple of the original purchase price, plus any accrued cumulative dividends, in the order the charter specifies. If proceeds run out mid-stack, the rest of the stack gets nothing.
4. Participation, where it exists
Participating preferred then shares in the remainder alongside common, up to its cap if one is stated. See /equity/liquidation-preference.
5. The conversion decision
Any series better off converting to common does so instead of taking its preference. This has to be solved, because one series converting changes the answer for the others.
6. Common stock
Whatever is left is divided across common shares and exercised options. Options with a strike above the resulting price will not be exercised at all.

The example company

One capital structure, five exit prices. The company has 6,000,000 shares of common outstanding plus 1,000,000 outstanding options — 7,000,000 common-equivalent shares. It raised a $2,000,000 Series Seed at $1.00 per share and a $12,000,000 Series A at $4.00 per share, both 1× non-participating, with the Series A senior to the Seed. It also has $2,000,000 of venture debt outstanding.

The capital structure before the exit
Layer	Amount or shares	Price paid	Fully diluted share
Venture debt	$2,000,000	—	—
Series A preferred (senior)	3,000,000 shares	$4.00	25.00%
Series Seed preferred (junior)	2,000,000 shares	$1.00	16.67%
Common and outstanding options	7,000,000 shares	—	58.33%
Total fully diluted	12,000,000 shares	—	100.00%

Series A invested $12,000,000 and Series Seed $2,000,000, giving a total preference stack of $14,000,000 with $2,000,000 of debt ahead of it.

The waterfall, across five exit values

Proceeds distribution by exit value
Exit value	Venture debt	Series A	Series Seed	Common + options	Common per share
$10,000,000	$2,000,000	$8,000,000	$0	$0	$0.00
$20,000,000	$2,000,000	$12,000,000	$2,000,000	$4,000,000	$0.57
$40,000,000	$2,000,000	$12,000,000	$5,777,778	$20,222,222	$2.89
$80,000,000	$2,000,000	$19,500,000	$13,000,000	$45,500,000	$6.50
$120,000,000	$2,000,000	$29,500,000	$19,666,667	$68,833,333	$9.83

Every row sums to the exit value. At $10,000,000 the Series A preference of $12,000,000 is not even covered, so it absorbs everything left after the debt. At $40,000,000 the Series Seed converts but the Series A does not. At $80,000,000 and above both convert and everyone shares the post-debt proceeds pro rata across 12,000,000 shares. Ignores transaction expenses, escrow and option exercise proceeds.

Read the two middle rows carefully, because they contain the whole idea. At a $40,000,000 exit the Series A holder takes its $12,000,000 preference: converting would give it 3,000,000 of 12,000,000 shares of the $38,000,000 left after debt, which is $9,500,000 — less than the preference. The Series Seed does the opposite: converting gives it 2,000,000 of the 9,000,000 remaining common-equivalent shares sharing $26,000,000, which is $5,777,778 against a $2,000,000 preference. So one series converts and the other does not, in the same transaction.

Where each series flips from preference to conversion
Series	Invested	Preference	Crossover exit value	Why
Series A	$12,000,000	$12,000,000	$50,000,000	Its 25% of the $48,000,000 remaining after debt is exactly $12,000,000.
Series Seed	$2,000,000	$2,000,000	$23,000,000	Its 2,000,000 of 9,000,000 common-equivalent shares sharing $9,000,000 is exactly $2,000,000.

The Seed crossover assumes the Series A is still taking its preference at that exit value, which it is. Change the seniority or the preference multiple and both crossovers move.

What it means for the people holding shares

The same table read as a return on investment tells a different story again. The Series Seed, which took the most risk and put in the least money, has the best multiple at every exit above $23,000,000 — because it converts early and rides the whole upside. The Series A is protected on the downside and capped in relative terms until $50,000,000.

Multiple on invested capital by exit value
Exit value	Series A ($12m in)	Series Seed ($2m in)	Common per share
$10,000,000	0.67×	0.00×	$0.00
$20,000,000	1.00×	1.00×	$0.57
$40,000,000	1.00×	2.89×	$2.89
$80,000,000	1.63×	6.50×	$6.50
$120,000,000	2.46×	9.83×	$9.83

Once the Series Seed converts, its multiple equals the common per-share price divided by the $1.00 it paid, which is why the last two columns match from $40,000,000 onwards.

For an employee, the practical reading is the last column of the first table. Multiply the common per-share figure by your vested shares, subtract your strike price per share, and that is the pre-tax gross before any escrow holdback. At the $20,000,000 exit — a real outcome that would be reported as an acquisition — a $1.00-strike option is worth nothing at all, even though the company sold for twenty million dollars.

What changes the shape of the waterfall

Structural variations and their effect

Structural variations and their effect
Feature	Effect on the common stock
A higher preference multiple, say 2×	Doubles the amount taken off the top and pushes every crossover later.
Full participation on a series	The series takes its preference and then also shares the remainder, so common receives less at every exit above the stack.
Capped participation	Same as full participation until the cap binds, then the series converts and common recovers.
Pari passu instead of stacked seniority	No difference when proceeds cover the whole stack; when they do not, the shortfall is shared proportionally rather than falling entirely on the junior series.
Cumulative dividends	Grow the preference every year without any cash moving, widening the zero band for common.
Outstanding debt	Comes off the top before all equity, so it lowers every equity payout dollar for dollar.
Unconverted SAFEs at the time of sale	Handled by the SAFE's own liquidity provision, typically a choice between the money back and converting at the cap.

Effects described against the example structure on this page. Which apply to you is a question about your certificate of incorporation, not about market convention.

The instrument-level detail sits in the sibling guides: preference structures at /equity/liquidation-preference, the clauses that create them at /equity/term-sheet, and the pre-round instruments that convert into the stack at /equity/safe-note and /equity/convertible-note. The waterfall is where all of them finally meet.

One last use for the same machinery. The allocation stage of a 409A valuation is a waterfall run across many possible exit values at once, weighted by probability — which is precisely how an appraiser separates the value of common stock from the value of preferred. See /equity/409a-valuation and /equity/fair-market-value.

Waterfall questions

What is a waterfall analysis?

A calculation that distributes exit proceeds down the capital structure in order of priority — creditors, then each preferred series by seniority and liquidation preference, then participation where it exists, then common stock. It is normally run across several exit values, because the answer changes shape as the price moves.

Who gets paid first when a startup is acquired?

Transaction expenses and any escrow holdback come out first, then debt and other creditors, then preferred stock in the seniority order set by the certificate of incorporation, then common stock last. Employee options are common stock, and they only pay out once everything above them has been satisfied.

Why would a preferred shareholder convert to common in an exit?

Because converting produces more money. A 1× non-participating holder converts once their ownership percentage of the available proceeds exceeds their liquidation preference. In the example on this page the Series A crosses over at a $50,000,000 exit and the Series Seed at $23,000,000.

Do employees get anything if the company sells for less than it raised?

Usually not. If the exit value is at or below the total of debt plus the liquidation preference stack, common stock — including all vested options — receives nothing. In the example, a $10,000,000 sale of a company that raised $14,000,000 pays common zero.

What is the difference between stacked and pari passu seniority?

Stacked seniority pays each preferred series in full, newest first, before the next one receives anything. Pari passu treats the series equally, so a shortfall is shared in proportion to their preferences. It makes no difference when proceeds cover the whole stack and a large difference when they do not.

How do I build a waterfall for my company?

Start from an accurate fully diluted cap table, add every liquidation preference with its multiple, participation terms and seniority, add outstanding debt, then solve the conversion decision at each exit value rather than assuming it. The calculator at /tools/waterfall-calculator does the solve; the inputs still have to be right.

Sources

Model legal documents — certificate of incorporation and model term sheet — National Venture Capital AssociationSource for the liquidation preference alternatives, participation and cap language, and the deemed liquidation event definition that makes an acquisition trigger the waterfall.Checked 11 Aug 2026
Delaware General Corporation Law, subchapter V, section 151 — classes and series of stock — Delaware Code OnlineThe statutory basis for stating rights on distribution of assets in the certificate of incorporation.Checked 11 Aug 2026
Safe financing documents — Y CombinatorThe liquidity event and dissolution provisions that determine how an unconverted SAFE is treated in a sale.Checked 11 Aug 2026
26 CFR § 1.409A-1(b)(5)(iv) — Valuation of service recipient stock — Cornell Legal Information InstituteWhy the same waterfall machinery is used to allocate value between preferred and common in a 409A appraisal.Checked 11 Aug 2026

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