Two payoff diagrams against exit value: debt pays rising value up to a fixed claim and then goes flat; equity pays nothing until a threshold and then rises with value. Preferred stock, SAFEs, convertible notes and venture debt sit in the middle.

A non-participating convertible preferred share is literally the two shapes stitched together: the debt-like flat line at low exits and the equity line at high exits. Every waterfall in this lesson is a kink between those two regimes.

A side-by-side table: venture debt (principal, interest, 2–5 year terms, often with warrants), convertible notes (debt that converts, with cap and discount), SAFEs (conversion into future equity, no maturity), preferred stock (rights set by contract under Delaware law) and common stock (one vote, residual claim).

The red notes give the practical reason each exists: notes and SAFEs avoid coordinating a priced round and defer valuation, while almost all VCs require preferred stock. Relay used all three in sequence: SAFE, seed preferred, Series A preferred.

Cash-flow rights at liquidation are grouped as liquidation preference, conversion, participation and dividends; other common terms include pro rata, anti-dilution, ROFR, co-sale, tag-along, drag-along and redemption rights.

Only the first group enters a waterfall calculation, but drag-along and redemption rights decide whether and when a sale happens at all. The faded note matters: holders of the same class can have different rights through a major-investor clause.

Area chart: below the invested amount, preferred takes 100% of liquidation value along the 45-degree line; above it, preferred is capped at 1× and common takes everything else.

The callout asks how this differs from debt. The payoff shape is the same, but preferred has no maturity date, no interest that accrues by default and no right to force repayment before a liquidation event, unless redemption rights were negotiated.

Same chart with the preferred band raised to twice the capital invested, so common receives nothing until proceeds exceed 2× the investment.

The callout states this structure is uncommon in venture capital. A 2× multiple matters most in exactly the moderate exits founders are most likely to face; at Relay's $40M exit a 2× Series A preference would take $24M before anyone else is paid.

Payoff chart for $2M invested for 40% with a 1× non-participating preference: preferred takes everything up to $2M, stays flat at $2M until $5M, then rises at 40% of value. Conditions: convert if 40% × value > $2M, i.e., value > $5M.

The flat segment between $2M and $5M is where the preference transfers value from common to the investor. In a multi-class cap table each class has its own flat segment and its own crossover, which is why Relay's waterfall needs iteration.

Chart for 1× participating preferred: the investor takes the preference and then shares in everything above it, so the preferred band keeps widening with value.

The callout notes participation is often capped (for example at 2× the investment), in which case the holder chooses between the capped participating payoff and converting. A capped participating security therefore has its own conversion crossover.

Two conclusions: investor and entrepreneur payoffs can diverge widely, especially for moderate exits; and preferred stock gives entrepreneurs strong incentives to aim for high payoffs.

Relay's numbers confirm both claims: at $40M common holders receive $21.78M (54.4% of proceeds) although they hold 60.87% of as-converted shares, while at $150M and above every class is paid strictly pro rata.