Meaning
The actual cash remaining for distribution to shareholders after all transaction expenses and outstanding debts are paid out of the gross transaction value represents the real return on an exit event. In a liquidity event, the net proceeds are calculated by subtracting legal fees and investment banking commissions from the total purchase price.
Deduction Schedule
Transaction expenses are listed in detail in the merger or acquisition agreement. These expenses are deducted directly from the escrow account before any distributions are made to the equity holders. Net proceeds are therefore highly sensitive to the size of these transaction costs.
Managing these fees is necessary for maximizing shareholder return.
Distribution Order
Preferred shareholders receive their allocated share of the net proceeds before any funds are distributed to common shareholders. This payout order is governed by the liquidation preference clauses in the articles of incorporation. If the net proceeds are insufficient to cover the preferred preference, the common shareholders receive nothing.
This priority structure is a standard feature of venture capital term sheets that aligns the interests of the investors with the exit valuation.
Liquidation Preference
Participating preferred stock allows investors to receive their preference amount and then share in the remaining net proceeds alongside the common shareholders. Non-participating stock, by contrast, requires the investor to choose between their fixed preference or converting to common stock to receive a pro-rata share. This choice depends on the total value of the exit.
