The acquisition waterfall

At close, the purchase price does not land equally on every share. It runs a waterfall: fees, creditors, escrow, liquidation preferences, then common. The headline is the top of that cascade, not the employee outcome.

The big idea

A simplified order:

1. Transaction fees and expenses (lawyers, bankers, escrow agent)
2. Debt and other creditor claims
3. Escrow holdback (parked, not yet distributed)
4. Preferred liquidation preferences, by seniority
5. Remaining proceeds to common (founders' common, exercised employee stock) and to option holders if the merger agreement treats in-the-money options as participating

A bakery that sells for $40 and owes the landlord, the caterer and a reserved tab does not split $40 among the cooks. The analogy breaks on conversion elections and on whether escrow is carved pro rata or held to backstop unpaid prefs — read the merger agreement.

Walking through a $40M cash deal

Gross                     40,000,000
− Fees                    −1,200,000
= Available at close      38,800,000
− Escrow (held back)      −4,000,000
= Distributable now       34,800,000

Senior Series B takes $20,000,000. Series A takes $10,000,000. Left for common:

34,800,000 − 20,000,000 − 10,000,000 = 4,800,000

About 12% of the headline, before splitting that common pool among founders and employees. A year later, if no indemnity claims, the $4M escrow releases and runs the same priority rules (deal-dependent). Here prefs were covered at close, so common's $4.8M at close is the main equity outcome.

Same stack, $25M deal. After $1.2M fees and $2.5M escrow, distributable ≈ $21.3M. Series B's $20M preference almost fills it; Series A gets ~$1.3M; common gets $0 at close. That is how "successful" acquisitions produce empty option exercises.

If Series B is 1× participating, B takes $20M plus its as-converted % of the residual. Common shrinks further. Always model participating vs non-participating.

Common mistakes

• Taking your % × headline as your check. Run fees, escrow and prefs first.
• Assuming escrow is extra common money. If prefs were not covered, escrow goes up the stack.
• Skipping the participating vs non-participating toggle. It is not cosmetic.

Check yourself

$40M gross, $1.2M fees, $4M escrow, $20M senior B + $10M A, both 1× non-participating. What does common get at close?

$4.8M.

Why can a $25M sale pay common nothing?

After fees and escrow, ~$21.3M is left; B's $20M preference takes almost all of it.

Key takeaways

• Headline ≠ employee outcome. Model fees, escrow, preferences, then common.
• Senior later rounds can zero common on deals that look large.
• Escrow follows the same priority, often a year later.
• Participating preferred takes another bite of the residual.

Further learning

Next: what happens to unvested equity in an acquisition.