What does pari passu mean?
Takeaway: Pari passu means on equal footing. It is used in the startup context to reference liquidation preferences. Pari passu liquidation preferences means that the different series of preferred stock both get paid out in an acquisition at the same time before the common stock.
The world of startup financing and equity structures can be complex and filled with specialized terminology. One such term that you may come across is “pari passu,” which has significant implications in the context of preferred stock issued by startups. In this post, we will break down the concept of pari passu and explain its relevance for startups and their investors.
What is pari passu?
“Pari passu” is a Latin phrase that translates to “on equal footing” or “in equal step.” In the financial world, it refers to the equal treatment of two or more parties in terms of their rights and obligations, typically in the context of debt or securities. In other words, when securities or obligations are pari passu, it means they rank equally with one another, and no party has priority over the other.
Pari passu in the context of preferred stock
Startups often issue preferred stock to their investors, which gives these stockholders certain preferences and rights over common stockholders. These preferences may include dividend rights, liquidation preferences, and voting rights, among others.
When multiple series of preferred stock are issued, it's crucial to understand how they rank in relation to each other, especially when it comes to liquidation preferences and dividend rights. This is where the concept of pari passu comes into play.
If two or more series of preferred stock are described as pari passu, it means they have equal rights and rank equally in terms of liquidation preferences and dividend rights. In other words, no series of preferred stock has priority over the other.
For example, let's say a startup has issued Series A and Series B preferred stock, both with a liquidation preference of 1x the original investment. If the company is sold or liquidated, and the liquidation preferences of Series A and Series B are pari passu, the proceeds from the sale or liquidation will be distributed proportionately among both series of preferred stockholders on an equal basis, after paying off any outstanding debts.
Why pari passu matters for startups and investors
The pari passu concept is essential for startups and investors for several reasons:
Fair treatment: By ensuring that multiple series of preferred stock are treated equally, pari passu helps maintain fairness among investors, preventing one group from having an unfair advantage over the others. However, sometimes the economics of the different series of preferred stock are very different (e.g., they were purchased for very different prices) or the new series of preferred stock may negotiate to “sit” on top of the existing series of preferred stock in the liquidation stack. By that, I mean that in a liquidation, the Series B would be paid before the Series A.
Simplified negotiations: Establishing pari passu terms during financing rounds can simplify negotiations, as it sets a level playing field for all preferred stockholders, making it easier to reach agreements on other terms.
Investment attractiveness: A pari passu structure can make a startup more attractive to investors, as they know they will be treated equally with other preferred stockholders, reducing concerns about the dilution of their rights in future financing rounds.
Conclusion
The concept of pari passu is a crucial aspect of preferred stock issued by startups, as it ensures equal treatment among different series of preferred stockholders. By understanding the implications of pari passu, both startups and investors can navigate the complexities of equity structures and financing rounds more effectively, ultimately contributing to the long-term success of the company.