Capital Stack Games

Founders dream of shared upside, but stacked terms decide who really wins. This essay unpacks liquidation preferences, participating shares, and the hidden hierarchy of venture capital.

Every founder remembers the day the term sheet arrived. The investor handshake, the champagne, the quiet relief that someone finally believed in the vision. The slide deck promised alignment: “We win when you win.”

It sounded simple enough — a partnership, not a power imbalance. You signed, built, scaled, raised again, and for a while, it all made sense. Until the exit.

The company sold for $100 million. Headlines congratulated you. Employees cheered in Slack. Your inbox filled with praise and old LinkedIn messages from people who suddenly remembered you existed. And then came the spreadsheet — the distribution waterfall.

The investors, you learned, had a 2x participating preference. That meant they got twice their money back before anyone else saw a cent — and then they participated in the remainder as if they were common shareholders. A few early angels had negotiated seniority, meaning they were paid before later rounds. Legal fees, transaction bonuses, and carve-outs chipped away at what was left. By the time it reached the common stock pool — you, your co-founders, and your employees — there was barely enough left to buy a decent apartment.

No one had lied. Every clause was written in black and white. You just hadn’t understood what the words meant in practice. You had built a company. They had built a contract. And when the two collided, the contract won.

This is how the venture game is designed to work. Not maliciously, but mechanically. Every round you raise doesn’t just add capital — it adds complexity. Each investor sits above you in the stack, protected by preference, priority, and payout rights that quietly reorder the definition of “success.” The headline valuation you celebrate rarely translates to the outcome you expect.

In the world of venture capital, equity is not democratic. The capital stack is a hierarchy — elegant, silent, and brutally efficient. And when things go sideways, it determines who survives, who walks away, and who just gets clapped on the way out.

In this issue of The Founder's Brew, we unpack the quiet architecture that decides who really gets paid when your start-up exits — the capital stack. Each funding round adds a new layer of preference, priority, and payout protection for investors. Founders often discover too late that “fair equity” isn’t fair at all. This essay explains how liquidation preferences, stacked terms, and participating shares silently rewrite outcomes, and why every founder must learn to read the fine print.

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More posts from this series:

The Start-up as an Asset Class

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🚀 Today’s Issue at a Glance

• The Hierarchy of Money

• Liquidation Preferences — The Silent Trap

• Stacked Terms and the Illusion of Alignment

• When Things Go Sideways

• Playing the Stack Smart

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In the mythology of start-ups, equity is portrayed as the great equaliser — a promise that everyone who builds shares in the upside.

Founders, employees, and investors are supposedly bound by a common purpose: grow the company, create value, and share the rewards. It’s an elegant idea, but it’s also a dangerous simplification. Because in the real mechanics of venture finance, not all equity is equal.

What determines who actually gets paid isn’t effort, title, or tenure — it’s position in the capital stack. The capital stack is the hierarchy of claims on a company’s proceeds. When money comes in, it does so through multiple layers of preference and priority. When money goes out — through an acquisition, IPO, or liquidation — it flows back down the same stack, top to bottom. Those at the top get paid first. Those at the bottom get what’s left, if anything.

Each funding round you raise reorders that hierarchy. Investors negotiate terms that quietly shift risk downward. Liquidation preferences guarantee they’ll recoup their investment, sometimes multiple times, before founders or employees see a cent. Participating preferred shares allow them to “double dip,” collecting both their preference and their share of the residual pot. Seniority clauses ensure earlier investors are repaid before later ones. The result is a structure that appears collaborative but functions like a queue, one where founders and employees often find themselves at the very end.

This isn’t villainy; it’s design. Venture capital is structured to protect money, not dreams. Liquidation preferences exist because most start-ups fail. Participating preferred exists because funds must deliver consistent returns even in mediocre exits. Each clause, in isolation, sounds rational. It’s the accumulation of them, across multiple rounds, investors, and instruments, that creates distortion. The founder’s ownership remains, but its economic value quietly erodes.

→ The tragedy is that most founders don’t learn this until it’s too late.

They celebrate high valuations without understanding the terms that underpin them, mistaking paper wealth for realised value. They imagine that “alignment” means equality, when it really means priority, theirs last.

Understanding the capital stack is venture literacy. It’s how founders protect themselves from the invisible arithmetic that turns victories into disappointments. Because in the venture game, equity isn’t just ownership. It’s position, and position is everything.

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