Written by Mercer Timmis*
What are Liquidation Preferences?
A liquidation preference is a contractual right that may be negotiated by a venture capital firm while providing financing to a business. A liquidation preference entitles preferred shareholders to receive a certain amount of money on the company's liquidation before anything is paid out to the holder of the other classes of shares. Liquidation preferences may be triggered by events such as bankruptcy, winding up the business, an extraordinary sale of all or substantially all of the company's assets, or a change of control of a company.
Usually, preferred shareholders get an amount equal to their original purchase price plus any accrued and unpaid dividends (the" liquidation price"). However, venture capital investors ask for additional features, such as a multiple liquidation preference. A multiple liquidation preference gives the investor the right to receive between 1 to 3 times the liquidation price.
From 2020 to 2021, venture firms saw a record level of inflowing capital that pushed company valuations higher. This business-friendly market meant that investors settled on a 1 times liquidation preference which ensured they would be paid back their initial investment before founders and employees.
Conversely, 2022 presents a different market where venture capital investment dropped to a six-quarter low amidst increasing interest rates, high levels of inflation, and a declining stock market. This weakened funding environment creates a lower risk appetite for investors where investors ask for more onerous terms. As such, investors are asking for a 2 to 3 times liquidation preference, meaning they would be paid back double or triple their money before other stakeholders.
Generally, a company's valuation tends to increase for each financing round. However, the current economic climate brings unfavourable company valuations and leads businesses to agree to more onerous terms to prevent a 'down round.' A down round occurs when a company raises money at a lower valuation than its previous round. The consequences of a down round are two-fold. First, raising funds at a lower valuation has a dilutive effect on existing shareholders. Second, it is a red flag that reduces investor confidence and employee morale. As such, liquidation preferences are prevalent in the current market because investors will agree to funding valuations equal to or higher than a company's previous round in return for 2 or 3 times multiple. These terms are attractive because, despite the underlying difficulties of the business, the investor is receiving 2 to 3 times their investment.
Options for the Business
If a company faces onerous liquidation preferences, the following compromises are available: First, suggest that the liquidation preferences operate only against management and founders' shareholding rather than against the equity of other investors (i.e., any friends or family). Second, place a cap on the return to the preferred shares so that in the event the company sees modest success, the preferred shareholders will do better by converting to common equity rather than relying on the liquidation preference.
Finally, when negotiating the terms of liquidation preferences, they should not provide for a "change of control" mechanism that results in the deemed liquidation in the event of an equity investment involving more than 50% of outstanding shares. Instead, the threshold should be much higher.
 Bryce C. Tinge, Start-up and Growth Companies in Canada: A Guide to Legal and Business Practices, 3rd ed (Canada: LexisNexis Canada Inc, 2018).
 The Information, “Startups Avoid Valuation Cuts with ‘Up Rounds in Name Only’ (11, October, 2022) online: The information < https://www.theinformation.com/articles/startups-avoid-valuation-cuts-with-up-rounds-in-nameonly?utm_source=substack&utm_medium=email>.
 Bloomberg, “VCs Need the Good Tweets” (13, October, 2022) online: Bloomberg, Matt Levine < https://www.bloomberg.com/opinion/articles/2022-10-13/vcs-need-the-good-tweets>.
Supra, note 1.
J.D. Candidate 2023
University of Calgary, Faculty of Law
Authored by Sabrina Sandhu*
A Not-For-Profit, or NFP, is an organization where the purpose is not for owners to generate a profit for themselves, nor is there any distribution of income to members, officers, or directors. The goals of an NFP can vary widely from artistic to scientific, and philanthropic to educational. When starting a NFP in Canada, one must make an important initial decision whether to incorporate federally or provincially. Each confers certain advantages and disadvantages. While the individual provinces have harmonized their process for incorporation, differences do exist in the margins. It is therefore important to understand the requirements of each province under consideration before making a decision on jurisdiction. This post will characterize the key distinctions between incorporating federally in Canada to that of the Province of Alberta.
The Canada Not-for-profit Corporations Act, or CNCA, is the governing legislation for incorporating federally in Canada. There are several advantages to the organization when incorporating under the CNCA. First, once federally incorporated, the organization may carry out its objectives in any province or territory they choose. Secondly, the name of the organization will remain unique nationally, in contrast to provincial registration where the name is only protected in that specific province. However, it may be more challenging to find a unique name nationally, than at the provincial level. Third, albeit paradoxical, the extent of financial review is lower when federally incorporated, where it may only be necessary to have an independent accountant review financial statements, rather than having to appoint an auditor which can be costly for an NFP. Fourth, under the CNCA only one individual is required to incorporate the NFP, compared to more than one at provincial levels. Fifth, perhaps the most important advantage is that under the CNCA, a federally incorporated NFP may engage in a business or trade to generate revenue specifically for use by the NFP. This enables the NFP the financial means to pursue broader Not-For-Profit objectives. Finally, the downside is that one is required to pay both the $250 online fee to incorporate federally, plus an additional extra-provincial registration fee to be paid in the provinces and territories that the organization conducts its operations in. In Alberta, the extra-provincial fee would be an additional $250.
Incorporation in the Province of Alberta.
If one were to incorporate in Alberta only, the organization would be incorporated under the Alberta Societies Act, or ASA. The key differences from federal incorporation are as follows. First, the fee to incorporate is only $50, which is less costly than federal incorporation. Second, selecting a name for the organization only requires an Alberta search, not a national database search, and therefore it is easier to obtain. However, if the organization subsequently wishes to pursue expansion into other provinces or territories, then the chosen name must undergo a search and clearance in that province as well. Third, instead of only one individual required to incorporate an NFP federally, the Alberta requires 5 or more individuals. Fourth, Alberta NFPs are required to have their annual financial statements audited, which can be costly to the NFP, whereas federally, as mentioned above, an exemption can be obtained that obviates the necessity for an external auditor. Finally, the most important distinction between federal incorporation is that an organization incorporated under the ASA is not permitted to engage in a business or trade to generate revenue for the organization. If the organization is financed primarily through donations, and it is not necessary for the organization to pursue additional revenue generation streams to fulfill its not-for-profit objectives, then this may not be a concern.
If you have questions or require additional information about incorporating an NFP in Canada, please reach out the BVC Clinic to chat with U of C Law Student.
*Sabrina Sandhu, MD FRCPC
JD Candidate 2023 (University of Calgary)
Anesthesiologist and Pain Medicine Physician
Clinical Assistant Professor
Department of Anesthesiology, Preoperative and Pain Medicine
University of Calgary
Blog posts are by students at the Business Venture Clinic. Student bios appear under each post.