Are capped participating preferreds unusual?
Well, it is option #3 in the term sheet – people generally go with option 1 or 2! – and is slightly more complicated to explain to founders and syndicate partners – hence these posts. This extra difficulty makes it less popular than alternatives 1 and 2.
So why use it? Well, it’s a compromise. We will (usually) ask for a 1x participating liquidation preference; sometimes the founders have enough leverage or credibility to convince us to accept a 1x non-participating liquidation preference instead; and sometimes we have to find the middle ground.
(Both parties should also be wary about setting a precedent. Angels might like an unlimited participation now, but a further round (or five) of venture capital money is planned, angels might not like those bigger investors having a participating preference getting paid out first. So we might prefer a capped participation in the angel round. This is partly because a following VC fund should not care so much about it: the capped participation does not impact on the “enormous proceeds” scenario (#3 in the last post), which is generally the VC investment model, and so might even ignore it.)