Why these terms exist, what they mean in real numbers, and how to keep your deal balanced

In many startup exits, founders walk away with far less than the headline price suggests. Why? Mostly because of two small clauses in most term sheets: liquidation preference and anti-dilution.

They decide who gets paid first, how much, and how ownership shifts when valuations change.

These are not traps. They’re tools designed to balance risk and reward between founders and investors. Understanding them early can make the difference between a fair deal and a painful surprise.

When you raise capital, you’re not just negotiating a valuation, you’re agreeing on how success and failure will be shared. Investors take real risk; if things go wrong, they can lose everything. Founders, on the other hand, want to ensure that when the company grows or exits, rewards flow fairly.

That’s where liquidation preference and anti-dilution come in. They define the mechanics behind the money: who gets what, when, and how the pie adjusts when conditions change.

The goal isn’t to punish or protect one side; it’s to set clear, predictable ground rules so both founders and investors can build with confidence.

1. Liquidation Preference: Who Gets Paid First (and How Much)

1x, 2x, 3x. Participating. Non-participating. Capped. What does this all mean?

If you’ve seen a term sheet before, you’ve probably come across phrases like “1x non-participating liquidation preference.”

They sound technical, but they decide something very real: who gets paid first when the company is sold, and how much they take before anyone else sees a franc.

At its core, liquidation preference defines the order of payout when a company is sold, merged, or wound down. It tells investors what they get back before the founders and employees receive their share.

For investors, it’s a form of downside protection, a way to recover their money if the outcome is smaller than expected.

For founders, it brings clarity to how exit proceeds are divided and what the real take-home looks like under different scenarios.

The basics

A typical liquidation preference is 1x non-participating, meaning the investor gets their original investment back or their ownership percentage of the proceeds, whichever is higher (but not both; no “double dipping").

Anything above 1x, like 2x or 3x, means the investor gets two or three times their money back before founders see anything.

A “participating” preference means the investor gets their money back and then also shares in the remaining pot with common shareholders, often called the “double dip.”

A simple case

Let’s say an investor puts in CHF 1 million for 10% of the company.

Later, the company sells for CHF 10 million.

Case A: 1x Non-Participating

The investor chooses between:

• Getting their CHF 1 million back, or

• Taking 10% of CHF 10 million = CHF 1 million.

Both are the same, so they simply get CHF 1 million.

The remaining CHF 9 million goes to the founders.

Balanced: The investor recovers their capital, the founders keep the upside.

Case B: 1x Participating

The investor first gets their CHF 1 million, then also takes 10% of the remaining CHF 9 million = CHF 0.9 million.

They walk away with CHF 1.9 million, while founders receive CHF 8.1 million.

Notice: The investor owns only 10% but captures almost 20% of the total exit.

Case C: 2x Non-Participating

The investor receives 2 × CHF 1 million = CHF 2 million before anyone else is paid.

Founders split the remaining CHF 8 million.

Result: The investor doubles their investment and takes one-fifth of the total exit value, even though they own only 10%.

When does it apply?

Liquidation preference typically applies during a liquidity event, which is any situation where shareholders receive cash or marketable securities in exchange for their shares (definitions might vary depending on the agreements, and lawyers). This includes:

• The sale of the company (trade sale or asset sale).

• A merger or acquisition where existing shares are converted or bought out.

• An IPO, just in some cases if preference shares are not automatically converted before listing.

It usually does not apply to internal share transfers or early partial buybacks unless specifically stated.

Always check the definition of “liquidity event” in the term sheet. Small wording changes can decide whether investors are first in line or share equally with founders.

Tips for founders

• In today’s market, a 1x non-participating liquidation preference is considered standard for venture deals. Any deviation, higher multiples or participation rights, should be carefully questioned and justified by the specific stage, risk, or structure of the investment.

• Check participation rights. If it says “participating,” ask for a cap or push for a non-participating structure.

• Model outcomes. Before signing, simulate different exit values to see how the preference affects everyone’s payout.

• Balance protection and motivation. A fair deal protects the investor’s downside but keeps founders motivated to grow the pie.

2. Anti-Dilution: Protecting Investors in a Down Round

Anti-dilution clauses protect investors if your next funding round happens at a lower valuation than before (so-called the “down-round”). They adjust the conversion price of earlier preferred shares so that those investors keep a fair share of the company even if the company’s valuation drops. From the founder’s point of view, this protection can lead to extra dilution. From the investor’s side, it keeps their early risk from being penalized too harshly.

Two main types

Full-Ratchet Anti-Dilution

A full-ratchet anti-dilution clause completely resets the investor’s conversion price to match the price of the new round, no matter how many new shares are issued.

In other words, if a company raises a down round, the earlier investor’s preferred shares convert as if they had invested at the new, lower price. This means they effectively get more shares for free, increasing their ownership percentage and pushing dilution onto the founders and other common shareholders.

Example:

Series A investor buys shares at CHF 5.00 each.

Series B happens at CHF 2.50 per share.

The investor’s original shares are now priced as if they had paid CHF 2.50, effectively doubling their share count. Founders and employees see their ownership shrink dramatically. That’s why full ratchets are rare in balanced venture financing.

Broad-Based Weighted Average Anti-Dilution

A broad-based weighted average clause is the most common anti-dilution protection used in venture deals today. It adjusts the investor’s conversion price when a new financing round is priced lower than the previous one, but instead of resetting it completely (like a full ratchet), it calculates a blended price that takes into account how big the new round is and how much cheaper the new shares are.

This approach protects investors without wiping out the founders’ ownership, making it the most balanced and widely accepted structure. If the company issues only a few cheaper shares, the impact on the old investors is small. If it issues many cheap shares, the adjustment is larger, but still proportional.

Example:

Series A at CHF 5.00 per share, 1,000,000 shares total.

Series B at CHF 2.50 per share, 200,000 new shares.

Using a weighted formula, the Series A price adjusts slightly (approximately to CHF 4.58). Investors gain modest protection, while founders avoid a major ownership hit.

Anti-Dilution Under Swiss Law

Swiss corporate law does not grant a statutory anti-dilution right. Instead, shareholders have a statutory subscription right to subscribe for newly issued shares pro rata in a capital increase, which preserves their percentage if they participate (Art. 652b CO). This right can be limited or excluded by a qualified shareholders’ resolution under Art. 704 CO, subject to equal-treatment and fair-pricing principles. As a result, anti-dilution protections in Swiss venture deals are contractual (e.g., broad-based weighted average), negotiated in the shareholders’ agreement.

Tips for founders

• Push for broad-based weighted average. It’s the most balanced and widely accepted.

• Avoid full ratchet if possible. It’s harsh and can scare off future investors.

• Clarify when anti-dilution applies. Not every round should trigger it, only those below the last valuation.

• Understand your subscription rights. Even without anti-dilution, you can sometimes protect your stake by participating in new rounds.

• Always run dilution scenarios before signing. A few percentage points can make a huge difference later.

• Watch the “precedent effect.” Once you accept a harsh anti-dilution term, it can become the new baseline for future investors. Terms rarely get softer in later rounds, so negotiating balance early protects you long-term.

3. How These Clauses Work Together

Liquidation preferences and anti-dilution provisions often appear side by side.

Together, they define how money and ownership shift between founders and investors when the company goes through highs and lows.

For example, an investor with both a 2x liquidation preference and full-ratchet anti-dilution would recover twice their investment first and then benefit from a larger ownership percentage if a down round occurs. That combination can significantly reduce the founder’s upside even in a decent exit.

Smart negotiation doesn’t mean removing these protections entirely. It means ensuring they serve their purpose, protecting investors’ downside without erasing founder motivation or future investment potential.

Final Thought

These clauses exist to create balance, not conflict. Investors want to manage risk. Founders need room to build and grow. A good term sheet finds a structure that lets both sides win together.

If you’re reviewing or negotiating these clauses and want to understand their real impact, let’s talk.