Exit planning math: how acquisition payout waterfalls and IPO conversions affect founder proceeds

Understanding Your Exit: Acquisition vs IPO Math for Founders

For most founders, the exit is a distant, abstract concept until it suddenly becomes very real. The conversations quickly shift from product and customers to enterprise values and payout waterfalls. The most pressing question becomes, “After everyone is paid, what do my team and I actually take home?” Accurately forecasting your own and the team’s take-home proceeds across multiple acquisition or IPO pricing scenarios is complex. The headline price is not the cash price, and understanding the math that bridges that gap is essential for any founder navigating one of the most significant moments in their company’s lifecycle. This guide breaks down the financial outcomes for founders in both an acquisition and an IPO, moving from the headline number to your post-tax reality. See the Finance for Technical Founders hub for related guides.

The Three Foundational Numbers That Define Your Exit Strategy

Before you can model any startup exit strategies, you need to anchor your calculations in three foundational numbers. These are the essential inputs for any spreadsheet you build to map out potential acquisition valuation basics and the reality of founder equity in exits. Missing any one of them makes an accurate forecast impossible, turning a strategic plan into a hopeful guess.

1. Enterprise Value: This is the headline price, the total value the acquirer is paying for the company. It represents the value of the ongoing business operations and is the starting point for all calculations. It is critical to remember that this figure includes both the company's equity and its debt; the acquirer is effectively buying the assets and assuming the liabilities.
2. Fully Diluted Share Count: This isn't just the shares you and your co-founders own. It includes all issued stock, all granted employee stock options (whether vested or unvested), and any warrants or other convertible instruments. It represents the total number of shares that would exist if every possible share was issued, which is the denominator used to calculate the final per-share price.
3. Liquidation Preference Stack: This defines who gets paid in what order, and how much. It’s the set of rules, established in your financing term sheets, that dictates how proceeds are divided among shareholders. For most modern, early-stage companies, the standard is 1x non-participating preferred stock. This structure means investors can choose to either get their initial investment back or convert their preferred shares to common stock to share in the upside alongside founders and employees.

The Core M&A Math: How the Payout Waterfall Works in Practice

In an acquisition, the proceeds flow down a specific path, with different parties taking their cut at each stage. This process, known as the payout waterfall, is the core of any M&A vs public offering analysis. Understanding each step is crucial to calculating what is left for the founders and the team. Let's walk through it step-by-step.

Step 1: From Enterprise Value to Net Proceeds

Before a single dollar reaches a shareholder, the company’s debts and transaction costs are paid directly from the enterprise value. This is the first cut. Lenders and advisors are paid first. This includes any outstanding bank debt, venture debt, and the fees owed to bankers and lawyers who facilitated the deal. A scenario we repeatedly see is founders underbudgeting for these costs. Investment banker and legal fees typically amount to 5-10% of the deal's enterprise value. For practical planning, a realistic budget for these transaction costs is 5-7% of the total enterprise value, covering everything from legal diligence to M&A advisory services. What’s left after these deductions is called Net Proceeds, which is the amount available for distribution to shareholders.

Step 2: The Liquidation Preference Payout

After Net Proceeds are calculated, the next step is to satisfy the liquidation preference stack. This is the downside protection investors negotiated for in their term sheets. The payout typically starts with the most recent investors (e.g., Series B) and works backward. With standard 1x non-participating preferred stock, each investor faces a critical choice: take their 1x investment back, or convert their preferred shares into common stock and receive a pro-rata share of the Net Proceeds. They will run the math and choose whichever option yields a higher return. This decision point is often the most complex part of exit scenario modeling, as it can prevent founders and employees from receiving anything in lower-value exits where investors simply take their money back, leaving nothing for common stockholders.

Step 3: The Common Stock Pool

After all transaction costs are paid and all investors who chose to take their liquidation preference are made whole, the remaining amount is the Common Stock Pool. This is the final sum to be divided on a pro-rata basis among all holders of common stock. This group includes founders, employees who have exercised their options, and any preferred investors who chose to convert to common stock because the pro-rata payout was more valuable than their 1x preference. The per-share price for common stock is calculated from this final pool, not the headline enterprise value.

A SaaS Company Example: The Waterfall in Action

To illustrate the M&A vs public offering math, consider a SaaS startup with a $50 million acquisition offer. The company has $15 million in total liquidation preferences from its investors. Following the waterfall, the headline price of $50 million is first reduced by debt and transaction fees. Using our 7% estimate, this amounts to $3.5 million, leaving $46.5 million in Net Proceeds. Next, the investors' liquidation preferences are paid. If the deal value isn't high enough for them to profit from converting to common stock, they will take their $15 million preference. This leaves a final Common Stock Pool of $31.5 million. This is the amount distributed to founders and employees, meaning their per-share price is based on a $31.5 million valuation, not the $50 million headline number.

Acquisition vs IPO Financial Outcomes for Founders: How the Math Changes

Is the math the same for an IPO? No. When considering your startup exit strategies, it is vital to understand that for an Initial Public Offering, the math fundamentally changes. The payout waterfall doesn’t apply. Upon a successful IPO, all preferred stock automatically and mandatorily converts to common stock. This is a critical part of the IPO process explained: the liquidation preference stack disappears entirely. All shareholders, from the latest Series B investor to the earliest employee with options, become owners of a single class of common stock in a publicly-traded company.

However, the concept of a "payout" is very different. An IPO is not a direct sale that results in immediate cash in your bank account. Instead, founder equity in exits of this type becomes public shares. Crucially, you cannot sell them right away. In an IPO, founders, executives, and early investors are typically subject to a 180-day lock-up period. This six-month window prevents insiders from selling shares immediately after the public offering, which helps provide market stability. The practical consequence for you is that your final financial outcome is subject to market volatility for at least six months post-IPO. The stock price on day one is not guaranteed to be the price you sell at, introducing a significant element of market risk to your personal net worth. For other ways to gain liquidity, see our guide on founder liquidity and secondary sales.

The Final Cut: How Taxes Impact Your Take-Home Proceeds

Once you have calculated your pre-tax proceeds, the final step in any exit scenario modeling is understanding how much you will actually keep. This is where early-stage exit planning for startups, particularly around corporate structure and geography, becomes immensely important. The decisions you make at incorporation can have a profound impact on your tax burden years later.

For US-Based Companies: Qualified Small Business Stock (QSBS)

The most powerful tax tool for US founders is Qualified Small Business Stock (QSBS). As of 2023, QSBS offers a potential US federal tax exemption on up to $10 million in capital gains or 10 times the cost basis, whichever is greater. This can result in a 0% federal tax rate on substantial gains from your exit. However, strict rules apply. To qualify, shares must be in a US C-Corporation, they must have been held for more than five years, and the company must have had less than $50 million in gross assets at the time of your investment. This status must be established and maintained from the earliest days of the company.

In the UK: Business Asset Disposal Relief (BADR)

In the UK, the primary equivalent tax incentive is Business Asset Disposal Relief (BADR), which was formerly known as Entrepreneurs' Relief. UK's Business Asset Disposal Relief (BADR) offers a reduced 10% Capital Gains Tax rate on the first £1 million of lifetime gains. While not as generous as QSBS, it provides a significant tax reduction compared to standard capital gains rates. BADR eligibility typically requires owning at least 5% of the company and being an employee or officer for at least two years leading up to the sale. This distinction is not trivial and highlights why navigating UK vs US tax rules must be a priority from incorporation.

Practical Takeaways for Your Startup Exit Strategy

Understanding the mechanics of acquisition vs IPO financial outcomes for founders is not just a theoretical exercise. It is a critical part of your job as a steward of the company and its stakeholders. The key is to move beyond the headline number and focus on the distributable proceeds that actually reach you and your team.

First, model everything. Use spreadsheets to build your own payout waterfall. Run multiple scenarios with different enterprise values to understand the breakpoints where investors would choose to convert to common stock instead of taking their liquidation preference. Creating best-case, base-case, and worst-case models will help manage expectations for yourself, your co-founders, and your employees.

Second, know your terms inside and out. Your cap table, financing documents, and option agreements are not just legal paperwork; they are the instruction manual for your exit. Untangling liquidation preferences and the impacts of your employee option pool should happen long before a letter of intent ever arrives. A clear understanding of these documents is essential for accurate exit scenario modeling.

Finally, plan for taxes from day one. Your ability to leverage powerful programs like QSBS in the US or BADR in the UK is determined by decisions made at incorporation and during early financing rounds, not in the final months before a sale. Consult with experienced tax advisors early and often to ensure your company is structured correctly to maximize take-home value for you and your team. For related guides and broader context, see the Finance for Technical Founders hub.

Frequently Asked Questions

Q: What is the difference between enterprise value and equity value?

A: Enterprise value is the total value of a company, including its debt and cash. It's the headline price in an acquisition. Equity value is what remains for shareholders after debt is subtracted from the enterprise value. In an exit, founders and investors are paid out from the equity value after all other obligations are met.

Q: How do unvested employee options affect the payout in an acquisition?

A: Unvested options are part of the fully diluted share count, which is used to calculate the per-share price. Often, an acquirer will accelerate the vesting of some options to retain key employees or cancel the unvested portion. The specific treatment is a key negotiation point during the M&A process and is defined in the acquisition agreement.

Q: What happens if the acquisition price is too low to cover liquidation preferences?

A: If the Net Proceeds from an acquisition are not enough to cover the total liquidation preferences owed to investors, then the common stockholders (including founders and employees) typically receive nothing. This is often called a "wipeout" or "recap," where investors get their money back first, leaving the common pool empty.

Q: Why is a 180-day lock-up period standard in an IPO?

A: The 180-day lock-up period prevents company insiders, like founders and early investors, from selling their shares immediately after an IPO. This helps stabilize the stock price by preventing a massive sell-off that could cause volatility. It gives the market time to establish a stable trading price for the newly public company's stock.