{ "site": "venture-capital.wiki", "section": "Exit mechanics", "url": "https://venture-capital.wiki/exits/", "reviewed": "2026-08-27", "license": "CC BY 4.0", "changes": "https://venture-capital.wiki/changes.json", "tables": [ { "title": "The consideration bridge, from enterprise value to a distribution", "intro": "One transaction, all deductions stated as inputs chosen for legibility. Each line is subtracted in turn; the waterfall is then run on the closing distribution and again on cumulative proceeds as the escrow is released. Every row of the waterfall sums to the amount available.", "columns": [ "Step", "Amount", "Running total" ], "rows": [ [ "Enterprise value agreed with the buyer", "100,000,000", "100,000,000" ], [ "Less net debt repaid at closing", "-6,000,000", "94,000,000" ], [ "Less working capital shortfall against the target", "-1,800,000", "92,200,000" ], [ "Less transaction expenses", "-3,000,000", "89,200,000" ], [ "Equity consideration available to the cap table", "-", "89,200,000" ], [ "Less escrow holdback at 10 percent, released later", "-8,920,000", "80,280,000" ], [ "Distributed at closing", "-", "80,280,000" ] ] }, { "title": "Escrow and earnout allocated on cumulative proceeds", "intro": "The same transaction. Each deferred payment is allocated as the difference between the waterfall at cumulative proceeds including it and the waterfall at cumulative proceeds without it. Series B and Series C are at their preference amounts throughout, so they receive none of any deferred payment.", "columns": [ "Distribution", "Seed", "Series A", "Series B", "Series C", "Common and pool" ], "rows": [ [ "Closing distribution of 80,280,000", "4,456,000", "8,000,000", "20,000,000", "30,000,000", "17,824,000" ], [ "Cumulative on full escrow release, 89,200,000", "5,880,000", "9,800,000", "20,000,000", "30,000,000", "23,520,000" ], [ "Cumulative if a 3,000,000 claim is allowed, 86,200,000", "5,430,000", "9,050,000", "20,000,000", "30,000,000", "21,720,000" ], [ "Cumulative with a 20,000,000 earnout achieved, 109,200,000", "8,880,000", "14,800,000", "20,000,000", "30,000,000", "35,520,000" ], [ "Increment from a full escrow release", "1,424,000", "1,800,000", "0", "0", "5,696,000" ], [ "Increment from the escrow net of the claim", "974,000", "1,050,000", "0", "0", "3,896,000" ], [ "Increment from the earnout", "3,000,000", "5,000,000", "0", "0", "12,000,000" ] ] }, { "title": "Asset sale against stock sale on the same 100,000,000", "intro": "A C corporation with a 10,000,000 tax basis in its assets. In an asset sale the corporation recognises the gain and pays entity-level tax before distributing; in a stock sale the consideration reaches the holders directly. A 21 percent rate is used, which is the stated federal corporate rate; state tax, asset character and the seller's attributes all move the real figure. Holder-level tax is outside the table.", "columns": [ "Quantity", "Asset sale", "Stock sale" ], "rows": [ [ "Headline consideration", "100,000,000", "100,000,000" ], [ "Corporate-level gain", "90,000,000", "None" ], [ "Corporate tax at 21 percent", "18,900,000", "0" ], [ "Distributable to the cap table", "81,100,000", "100,000,000" ], [ "Seed", "4,620,000", "7,500,000" ], [ "Series A", "8,000,000", "12,500,000" ], [ "Series B", "20,000,000", "20,000,000" ], [ "Series C", "30,000,000", "30,000,000" ], [ "Common and pool", "18,480,000", "30,000,000" ], [ "Common's share of the corporate tax", "11,520,000 of 18,900,000, or 60.952 percent", "-" ] ] } ], "entries": [ { "id": "consideration-bridge", "term": "The bridge from headline price to distributed consideration", "definition": "The waterfall runs on equity consideration, not on the price in the announcement. Four deductions stand between them, and because the waterfall has kinks at each conversion flip point the deductions do not reduce every holder proportionally.", "formula": "Equity consideration = enterprise value - net debt - working capital adjustment - transaction expenses. Closing distribution = equity consideration - escrow. Run the waterfall on each figure separately", "fields": [ { "label": "The bridge", "value": "100,000,000 less 6,000,000 of net debt, 1,800,000 of working capital shortfall and 3,000,000 of expenses = 89,200,000", "mono": true }, { "label": "Escrow", "value": "8,920,000 held back, so 80,280,000 is distributed at closing", "mono": true }, { "label": "Closing waterfall", "value": "Seed 4,456,000, Series A 8,000,000, Series B 20,000,000, Series C 30,000,000, common and pool 17,824,000", "mono": true }, { "label": "If the whole 100,000,000 had reached the cap table", "value": "Seed 7,500,000, Series A 12,500,000, common and pool 30,000,000", "mono": true }, { "label": "Cost to common of the bridge", "value": "12,176,000 of the 19,720,000 of deductions, or 61.744 percent", "mono": true }, { "label": "Common's ownership", "value": "38.400 percent - so common absorbs a substantially higher share of every deduction than it owns of the company", "mono": true } ], "notes": [ "Common bears more than its ownership share of every deduction above the aggregate preference, because the deductions come out of the residual and the residual is shared by a smaller group than the whole cap table. The multiplier is common's ownership divided by the residual group's total.", "The working capital adjustment and the expenses are the two lines a seller can still influence at signing, and they are the two that are usually delegated to the finance team. Both are worth the founders' attention for the same reason the preference is.", "Net debt reduces the consideration and does not enter the preference, so a facility drawn to extend runway is repaid ahead of the entire preferred stack. That is the same arithmetic as the venture debt comparison, seen from the other end.", "Ask for the bridge as a schedule with each line named, alongside the allocation schedule. Two documents, and between them they answer every question about who receives what." ] }, { "id": "escrow-release-schedule", "term": "An escrow release schedule, with and without a claim", "definition": "An escrow is a deferred part of the consideration, released on a schedule and reduced by any allowed claim. Because it is allocated on cumulative proceeds, a claim does not reduce every holder in proportion - it reduces the residual claimants first and most.", "formula": "Release to holder i = allocation at (closing + release) - allocation at closing. A claim of K reduces the release to (closing + escrow - K) and the increments are recomputed", "fields": [ { "label": "Setup", "value": "8,920,000 escrow on a closing distribution of 80,280,000, releasable after a stated period", "mono": true }, { "label": "Full release", "value": "Seed 1,424,000, Series A 1,800,000, Series B 0, Series C 0, common and pool 5,696,000", "mono": true }, { "label": "Release after a 3,000,000 claim", "value": "Seed 974,000, Series A 1,050,000, common and pool 3,896,000", "mono": true }, { "label": "Common's share of the claim", "value": "1,800,000 of 3,000,000 = 60.000 percent", "mono": true }, { "label": "Why Series B and C receive nothing", "value": "Both are at their preference amounts at every figure between 80,280,000 and 109,200,000, so no deferred payment changes their allocation", "mono": true }, { "label": "Time value", "value": "The release is nominal, so a holder receiving 5,696,000 eighteen months later has received less than that in present value, with no adjustment in the documents", "mono": true } ], "notes": [ "The holders with the most to lose from a claim are the ones with no ability to defend it, because the residual claimants are the common and the converted series while the claim is usually negotiated by the buyer with a stockholder representative appointed by the preferred.", "That misalignment is the reason to read the indemnification provisions as an economic term. A cap set at the escrow amount, several rather than joint liability, and a materiality scrape are each worth a specific number to common.", "Representation and warranty insurance changes the arithmetic by moving the claim off the escrow and onto a policy, at a premium paid out of the consideration. The premium is a certain deduction against an uncertain one, and it is a computable trade.", "Present value is never adjusted for and it should at least be quantified. Eighteen months of deferral on a tenth of the consideration is a real cost borne almost entirely by the residual claimants." ] }, { "id": "earnout-across-the-stack", "term": "An earnout allocated across a preferred stack", "definition": "An earnout is contingent additional consideration. Allocated on cumulative proceeds it behaves as a second tranche of the same waterfall, which means it goes almost entirely to the residual claimants - the holders who have the least influence over whether the earnout is achieved.", "formula": "Earnout allocation to holder i = allocation at (closing consideration + earnout) - allocation at closing consideration", "fields": [ { "label": "Setup", "value": "A 20,000,000 earnout on top of the 89,200,000 of equity consideration, payable if stated targets are met", "mono": true }, { "label": "Allocation if achieved", "value": "Seed 3,000,000, Series A 5,000,000, Series B 0, Series C 0, common and pool 12,000,000", "mono": true }, { "label": "Check", "value": "20,000,000 allocated", "mono": true }, { "label": "Common's share", "value": "60.000 percent of the earnout, against a 38.400 percent ownership", "mono": true }, { "label": "Who controls achievement", "value": "The buyer, after closing, through the operating decisions of the acquired business", "mono": true }, { "label": "If not achieved", "value": "Every holder receives the closing allocation and nothing more; the entire variance sits with the residual claimants", "mono": true } ], "notes": [ "An earnout transfers variance to the residual claimants and control to the buyer. That is the structural objection to it, and it is stronger than the usual objection about measurement disputes.", "Because the preferred are already whole at these figures, the preferred holders negotiating the deal have no economic interest in the earnout at all. The parties who care are the founders and the employees, and they are usually not at the table for that clause.", "The protections that matter are operational rather than financial: a covenant to run the business consistently with past practice, a defined measurement methodology, an acceleration on a subsequent sale or on termination of key employees, and an offset restriction so the earnout cannot be used to satisfy indemnity claims.", "Model the transaction with the earnout at zero. If the deal is only acceptable with it achieved, the earnout is being used to bridge a valuation gap rather than to price genuine uncertainty." ] }, { "id": "allocation-schedule", "term": "The allocation schedule is the document that decides who gets paid", "definition": "The charter states the waterfall and the allocation schedule applies it. It is delivered late, prepared by the company's counsel, certified by an officer, and relied on by the buyer's paying agent. It is also the only document in the transaction that states each holder's number.", "formula": "For each holder: shares held, class and series, election where applicable, gross allocation, escrow portion, withholding, and net payment at closing. The gross allocations must sum to the consideration available", "fields": [ { "label": "What it must reconcile to", "value": "The stock ledger, the option ledger, the charter waterfall, the carve-out plan if any, and the consideration bridge", "mono": false }, { "label": "Where errors live", "value": "Conversion elections computed series by series instead of jointly; the carve-out omitted because it is not on the cap table; unvested and terminated options treated inconsistently; the escrow allocated pro rata to closing rather than cumulatively", "mono": false }, { "label": "The arithmetic check", "value": "Every column sums: gross allocations equal the consideration available, escrow portions equal the escrow, and each series' figure equals what the charter formula produces at that consideration", "mono": true }, { "label": "Worked check on this transaction", "value": "Seed 4,456,000 + Series A 8,000,000 + Series B 20,000,000 + Series C 30,000,000 + common and pool 17,824,000 = 80,280,000", "mono": true }, { "label": "Rely on it at your peril", "value": "The schedule is usually accompanied by an indemnity from the company to the buyer and the paying agent for errors in it, which means the risk of a mistake sits with the selling holders", "mono": false } ], "notes": [ "Ask for the schedule in draft, with the formula for each line shown rather than only the result. Every holder is entitled to check the arithmetic that produces its own number, and the arithmetic is not complicated - it is the four expressions in the liquidation section of this corpus.", "The most common material error is an election computed in charter order rather than solved jointly, because that is what a spreadsheet built one row at a time produces. It is wrong precisely in the exit range where the answer matters.", "The second most common is the carve-out, which is documented as a bonus plan and never appears on the cap table. A schedule built from the stock ledger alone omits the most senior claim in the structure.", "Options require their own treatment: vested in the money, vested out of the money, unvested, and terminated but within the exercise window are four different populations with four different outcomes, and the plan and the merger agreement have to agree on each." ], "source": "Delaware General Corporation Law section 251 and the NVCA model Amended and Restated Certificate of Incorporation (liquidation provisions)" }, { "id": "asset-sale-versus-stock-sale", "term": "An asset sale costs the common most", "definition": "In an asset sale by a C corporation the entity recognises the gain and pays tax before anything is distributed, so the same headline price produces a smaller distribution. Because the shortfall comes out of the residual, the common bears far more of it than its ownership share.", "formula": "Distributable = consideration - corporate tax on the gain. Then run the waterfall. Common's share of the tax = its proceeds at the full consideration less its proceeds at the reduced figure", "fields": [ { "label": "Setup", "value": "100,000,000 headline, 10,000,000 tax basis, a 21 percent corporate rate", "mono": true }, { "label": "Corporate tax", "value": "0.21 * 90,000,000 = 18,900,000, leaving 81,100,000 distributable", "mono": true }, { "label": "Stock sale", "value": "Seed 7,500,000, Series A 12,500,000, Series B 20,000,000, Series C 30,000,000, common and pool 30,000,000", "mono": true }, { "label": "Asset sale", "value": "Seed 4,620,000, Series A 8,000,000, Series B 20,000,000, Series C 30,000,000, common and pool 18,480,000", "mono": true }, { "label": "Common's share of the tax", "value": "11,520,000 = 60.952 percent of it, on a 38.400 percent ownership", "mono": true }, { "label": "Series B and C", "value": "Unchanged - both are at their preference amounts under either structure", "mono": true } ], "notes": [ "The buyer's preference for an asset purchase is about liabilities and tax basis, and the seller's preference for a stock deal is about the entity-level tax. The gap is negotiated as price, so the form of the transaction is an economic term.", "The holders who bear the cost of an asset sale are not the holders who negotiate the form. The preferred are whole either way at these figures, and the founders and employees absorb almost two-thirds of the tax.", "Corporate attributes change the arithmetic materially. Loss carryforwards, the character of the assets, and state tax all move the figure, and a company with substantial losses may face little entity-level tax at all - which is worth establishing before conceding the form.", "The rate used here is the stated federal corporate rate and the example is arithmetic, not tax advice. The structural conclusion - that an entity-level tax is borne mostly by the residual claimants - does not depend on the rate." ], "source": "Delaware General Corporation Law section 271 (sale of substantially all assets)" }, { "id": "qsbs-on-exit", "term": "Applying the section 1202 exclusion at the exit", "definition": "The exclusion is computed per holder and per issuer, against a ceiling. On a founder position with near-zero basis the ceiling is the statutory dollar amount, and it is a small fraction of the gain on a successful exit.", "formula": "Excluded gain = tier fraction * min(gain, max(K, 10 * aggregate adjusted basis)). Taxable gain = total gain less excluded gain", "fields": [ { "label": "Setup", "value": "A founder holding 8,000,000 shares with an aggregate basis of 8,000, at an exit of 250,000,000 where all preferred converts and the per-share value is 10.2000", "mono": true }, { "label": "Proceeds and gain", "value": "81,600,000 of proceeds, 81,592,000 of gain", "mono": true }, { "label": "Ceiling", "value": "max(K, 10 * 8,000). With K taken as 15,000,000 the ceiling is 15,000,000", "mono": true }, { "label": "Excluded and taxable", "value": "15,000,000 excluded at a 100 percent tier, which is 18.384 percent of the gain. 66,592,000 remains taxable", "mono": true }, { "label": "Two founders holding the same position between them", "value": "Each has its own ceiling, so 30,000,000 of gain is excluded rather than 15,000,000", "mono": true }, { "label": "A holder that paid real money", "value": "An investor with a 20,000,000 basis has a ten-times-basis ceiling of 200,000,000, so the alternative test is the operative one for it and not for the founder", "mono": true } ], "notes": [ "The exclusion is per holder, which makes it additive across founders, family trusts and any other qualifying holder of separately issued stock. That is why the planning around it happens years before the exit and involves who holds the stock rather than what the company does.", "The ten-times-basis alternative is where the design shows: it is generous to holders who paid cash and irrelevant to holders who paid par. Founders are systematically in the second group.", "Every parameter above - the tier percentages, the holding periods, the per-issuer ceiling and the gross-asset test - is statutory and was amended for stock acquired after 4 July 2025. Read the current statute; this entry states the mechanism and uses one set of figures to show the arithmetic.", "The tests are applied at issuance and at disposition, and both can fail for reasons that have nothing to do with the exit: an entity conversion, a redemption within a lookback period, or gross assets crossing the ceiling before the stock was issued." ], "source": "IRC section 1202" }, { "id": "tender-offer-pricing-versus-last-round", "term": "Pricing a tender relative to the last round", "definition": "A secondary or company-run tender is a purchase of common stock, and the last round set a price for preferred stock. The two are different securities on the same cap table, so a tender priced at a discount to the round is not a markdown - it is a different instrument at a different price.", "formula": "Discount to the last preferred price = 1 - tender price / preferred price. The economically comparable figure is the tender price against the common fair market value, not against the preferred price", "fields": [ { "label": "Setup", "value": "The Series B price is 5.1000. A tender is offered for common at 4.5000", "mono": true }, { "label": "Discount to the preferred price", "value": "11.765 percent", "mono": true }, { "label": "Against the assumed common fair market value of 2.0400", "value": "The tender is at 2.21 times the appraised common value", "mono": true }, { "label": "Consequence for option strikes", "value": "A large arm's length purchase of common at 4.5000 is evidence of the fair market value of common and will be weighed in the next 409A analysis", "mono": true }, { "label": "Consequence for the seller", "value": "Proceeds are certain and the position is given up before any preference is cleared, which is worth most when the aggregate preference is large relative to plausible exits", "mono": true }, { "label": "Consequence for the buyer", "value": "Common with no preference, no protective provisions and no anti-dilution, at a price below the last preferred round", "mono": true } ], "notes": [ "The gap between the tender price and the preferred price is doing real work in the appraisal. A tender priced at or above the preferred price is very hard to reconcile with a common value well below it, which is one reason company-run tenders are priced below the round.", "A tender is the cheapest available mechanism for raising the strike on every option granted afterwards, and that consequence is rarely stated to the employees being offered liquidity in it.", "For a seller, the comparison that matters is the tender price against the expected value of the same shares through the waterfall, not against the last round price. Below the aggregate preference the shares are worth nothing, so certainty is worth a great deal.", "Tenders are purchase offers to a class of holders and carry process requirements that a single negotiated transfer does not. The pricing is the easy part." ] }, { "id": "working-capital-adjustment", "term": "The working capital adjustment, and why it is a price term", "definition": "The purchase price is agreed on the assumption that the business is delivered with a normal level of working capital. The adjustment settles the difference between that target and the actual figure at closing, and it reduces the equity consideration dollar for dollar.", "formula": "Adjustment = actual closing working capital - target working capital. A negative figure reduces the consideration; a positive figure increases it. The adjustment flows into the equity consideration before the waterfall runs", "fields": [ { "label": "Setup", "value": "A target of 5,000,000 against an actual closing figure of 3,200,000", "mono": true }, { "label": "Adjustment", "value": "3,200,000 - 5,000,000 = -1,800,000, reducing the equity consideration to 89,200,000", "mono": true }, { "label": "Effect on common", "value": "Common and pool receive 17,824,000 rather than the 19,248,000 they would have received without the shortfall - a cost of 1,424,000 from an 1,800,000 adjustment", "mono": true }, { "label": "Common's share", "value": "79.111 percent of the adjustment", "mono": true }, { "label": "Where the target comes from", "value": "A negotiated average of historical months, adjusted for seasonality and for items the parties agree to exclude. It is a negotiation, not a measurement", "mono": true }, { "label": "The estimate and the true-up", "value": "A closing estimate is used to fund the payment and a post-closing statement settles the difference, usually against a separate holdback", "mono": true } ], "notes": [ "The definition of working capital for this purpose is bespoke in every deal. Deferred revenue, accrued bonuses, capitalised software costs and transaction expenses are each argued in or out, and each decision moves the target.", "Because the target is negotiated and the actual is measured on the negotiated definition, the same balance sheet can produce very different adjustments. The definition is the term; the arithmetic is trivial once it is fixed.", "A company that manages cash tightly into a closing will collect receivables and delay payables, which raises the closing figure and is exactly what the adjustment mechanism is designed to neutralise. A well-drafted definition anticipates it.", "Common bears more than its ownership share of the adjustment, for the same reason it bears more of every other deduction: the reduction comes out of the residual." ] }, { "id": "appraisal-rights", "term": "Appraisal rights, and the risk they create for the consideration", "definition": "A stockholder that dissents from a merger and follows the statutory procedure can ask a court to determine the fair value of its shares and be paid that instead of the merger consideration. The exposure is a claim against the surviving company, which in a deal with an escrow and an indemnity becomes a claim against the selling holders.", "formula": "Exposure = dissenting shares * (determined fair value - merger consideration per share) plus statutory interest. Fair value is determined without reference to the preference where the court concludes the charter does not bind it", "fields": [ { "label": "Why it matters to a venture cap table", "value": "Fair value is a going-concern valuation of the shares, and a court is not obliged to accept a contractual waterfall as the measure of value for the dissenting class", "mono": true }, { "label": "Worked exposure", "value": "1,000,000 dissenting common shares against a merger consideration of 1.8938 a share. A determination of 3.0000 a share creates an exposure of 1,106,200 plus interest", "mono": true }, { "label": "Who bears it", "value": "Usually the selling holders, through the indemnity and the escrow, which means the residual claimants absorb most of it", "mono": true }, { "label": "Why it is usually avoided", "value": "A drag-along obliges holders to vote in favour, and a holder that votes in favour loses appraisal. Written consent from a large majority plus a drag removes most of the exposure", "mono": true }, { "label": "The procedural requirements", "value": "Strict: no vote in favour, a written demand before the vote, continuous holding, and a timely petition. Most attempts fail on procedure rather than on value", "mono": false }, { "label": "Closing condition", "value": "Buyers commonly require that dissenting shares be below a stated percentage as a condition to closing", "mono": true } ], "notes": [ "The drag-along is the practical answer to appraisal risk, which is why the drag's trigger is a closing mechanic and not only a governance term. A drag that cannot be exercised leaves the appraisal exposure open.", "Appraisal is one of the few routes by which a common holder can challenge a waterfall outcome, which is why it is worth understanding from both sides: as a risk to the consideration and as the residual claimants' only leverage.", "The exposure is asymmetric in a low-price deal. Where the consideration to common is near zero because the preference absorbs everything, a fair value determination has a great deal of room above it.", "Nothing here is legal advice and the procedural requirements are unforgiving. The arithmetic point is that an appraisal claim is a contingent liability of the consideration and belongs in the bridge alongside the escrow." ], "source": "Delaware General Corporation Law section 262 (appraisal rights)" } ] }