Meaning
Contractual requirements for a minimum distribution ensure that specific investors receive a set percentage on their capital before any profits are shared with other stakeholders. This preferred return acts as a hurdle that must be cleared to trigger broader profit participation. The arrangement protects the downside for the capital provider by guaranteeing a first claim on available cash.
Obligation for this payment ends once the specified return threshold is met or the assets are exhausted.
Priority Payment
Investors negotiate these terms to mitigate the risk of early stage backing. When a company is sold, the preferred return must be paid in full from the proceeds. For a founder, this means their own equity only gains value after the investors are satisfied.
This mechanism dictates the minimum exit price required for the founder to see a financial gain.
Founder Hurdle
Operating a business under a heavy preference burden creates constant pressure on the leadership. The founder must generate enough growth to exceed the compounding return owed to the investors. This requires an immense expenditure of energy and hours.
If the company grows too slowly, the preferred return might eat the entire exit value.
Structural Constraint
Terms governing the return often include compounding interest or participation rights. These features increase the total amount owed over time. A founder in a late stage seat must manage the company with this growing liability in mind.
