When a startup achieves a successful exit—whether that be an acquisition, IPO, or secondary sale—founders and employees often dream of large paydays. We’ve all seen the news headlines celebrating nine or ten-figure acquisitions. Everyone must walk away with a payout, right? Not necessarily. 

Before the celebration can begin, there's a complex reality that determines who gets paid, how much, and in what order.

This hierarchy of payouts is governed by a mechanism known as liquidity preferences.

Whether you're a founder raising capital or an investor negotiating terms, understanding how liquidation preferences work can help you set yourself up for a successful financial outcome upon an exit. In this article, we’ll explain how liquidation preferences work and what to watch out for in a term sheet. 

A liquidity preference is a clause that specifies how proceeds from a liquidity event are distributed among shareholders. In most cases, it guarantees that preferred shareholders (typically investors) receive their initial investment—or a multiple of it—before common shareholders (usually founders, employees, and early angels) get anything.

Liquidation preferences generally protect against an investor’s downside risk—that is, if there’s an exit at a lower valuation than the valuation at which they invested. 

However, in an upside scenario, where the exit valuation is higher than the valuation at which an investor came in, liquidation preferences are usually a moot point as investors will simply choose to convert their shares to common stock and take their pro rata share of the net proceeds. Converting your preferred shares to common stock is a typical occurrence when there is an exit event—it simplifies a company’s cap table upon exit, creates one single share class instead of two (or more), and enables shareholders to participate in the sale proceeds. 

Let’s understand a little bit more about how liquidation preferences are structured.

The building blocks of liquidation preferences

For startups that have raised multiple rounds of financing, liquidation preferences are often stacked. Later investors (Series B, C, etc.) typically have senior preferences, meaning they get paid before earlier investors.

This creates a waterfall payout effect: exit proceeds cascade from the most senior investor down. If the sale price is low, early investors—and especially founders and employees—might end up with a much lower amount, or in some cases, even nothing.

Some deals use pari passu treatment, where all investors share proceeds proportionally regardless of round. Founders should understand which model and the extent of liquidity preferences they are willing to accept as they negotiate terms.

This is the most visible part of the preference. A 1x liquidation preference means the investor gets back 100% of their original investment before anyone else gets paid (this is the most common in private markets). A 2x means they get double their initial investment. 3x—triple.

While 1x non-participating preferences have become standard in most early-stage deals, later-stage rounds or down rounds might include 2x or even 3x multiples as a way to de-risk the investment.

Why it matters: In a modest exit scenario, high multiples can consume a large chunk of the proceeds—leaving little for everyone else. This is the most common reason why entrepreneurs can sometimes walk away with nothing, even if they exit the company for nine or ten figures. Preference multiples can add up and raise the stakes for a big exit, so common shareholders still walk away with proceeds. 

Participation rights are a clause included in the initial term sheet provided by an investor, governing how the investor will participate in the proceeds upon an exit event. Participation rights can be simply broken down into two different types:

Some participating preferred shares include a cap (e.g. 2x return), after which the investor must convert. This protects founders and common shareholders in high-value exits while still rewarding investors in low-to-mid outcomes.

A simple example of a liquidation preference 

Let’s say a company raises $10M from Series A investors on 1x participating preferred shares with a 2x cap. Years later, the company is acquired for $40M. And let’s assume the Series A investors own 25% of the company.

In a common but unfortunate example, let’s take a company that raised $30M across three stacked rounds and gets acquired for only $25M. In that case, common shareholders would walk away with nothing.

Key details to look out for in a term sheet

Some preferred stock comes with cumulative dividends, meaning unpaid dividends accrue over time and must be paid out during a liquidity event. This is less common in early-stage deals, but more prevalent in growth or PE-style rounds. Founders should be cautious: over time, accrued dividends can quietly chip away at the exit pool.

Participating preferred shares can discourage new investors. If too much of the future upside is already spoken for due to prior participation rights, new investors may hesitate to come in unless those terms are cleaned up. This "preference overhang" can stall a company's fundraising or lower its valuation.

It’s important to remember that employee stock options convert into common shares. If the liquidation preferences eat up most of the proceeds, your team might walk away from a sale with nothing. That has major implications for retention and morale.

Not all liquidation preferences are bad. In fact, they can be essential for getting deals done. But founders need to understand the implications and use them strategically.

Remember: The terms you negotiate today can shape outcomes years down the line.

Zest is digitizing private market transactions, building tools to streamline how entrepreneurs, funds, and investors transact. Our platform is designed to save you time and reduce administrative costs, simplifying the end-to-end transaction process.

When a company exits, proceeds aren’t always split by ownership percentage. This article breaks down how liquidation preferences work—so you’re better prepared when raising or investing in your next deal.

Liquidation preferences: what you need to know 

Navigating relationships with your shareholders and board members is a crucial part of an entrepreneur’s journey. In the early days, your investors might just be a couple of supportive angels or family, and governance feels informal. But as you raise larger rounds, your investor base and board will expand, bringing more structure and expectations. Handled well, these relationships become a source of strength and guidance. Handled poorly, they can lead to serious conflicts.

In this article, we’ll explain what you need to know to manage your relationships with your shareholders and board members. 

How governance and decision-making evolve over time

When a company is just starting out, decisions are usually quick and entrepreneur-led. But, once professional investors come on board, governance begins to formalize, typically through establishing a board of directors during the Seed or Series A round. 

By later stages, your board may expand to 5-7 members or more, requiring decisions through board votes rather than unilateral entrepreneur choices.

Throughout this growth, you’ll want to pay close attention to 

 outlined in your shareholder agreements—specific actions needing special investor or board approval. These will be a driving factor in how decision-making is approached at your company. 

Governance throughout your company lifecycle 

Governance at this stage is relatively light. If a formal board exists, meetings may be infrequent and casual. Entrepreneurs can make most decisions quickly without seeking approval because early investors usually trust you to iterate and find product-market fit. 

Reserved matters for a seed round, if any, tend to cover only big irreversible decisions (for example, selling the company, issuing new stock, or taking on major debt) and are there to prevent a rogue decision that could harm investors’ interests. Many early investments are done via SAFE or convertible notes, which don’t give investors voting rights until they convert, meaning day-to-day control remains with common shareholders in the beginning.

Managing relationships with early investors is mostly about communication and trust. A wise practice is to send regular update emails (monthly or quarterly) highlighting progress, key metrics, and challenges. By communicating proactively (rather than avoiding them out of fear), you turn investors into allies and mentors.

It’s also important to set expectations at this stage. Talk with your investors about how involved they want to be and how you’d like to use their expertise. Some angels prefer a very hands-off approach, while others might enjoy being a sounding board for you. Setting these expectations early on can ensure that you and your investors stay aligned as you navigate challenges. 

Governance and decision-making now become far more formal as you move into a Series B+ phase. Expect to have board meetings regularly (often every 6-8 weeks or at least quarterly) with prepared agendas, slide decks of company KPIs, and formal minutes—major strategic decisions usually get deliberated in these meetings. 

You’ll also find that certain actions require explicit board or investor approval per the terms of your Series A/B shareholders’ agreement (“reserved matters”). Examples could include changing the company’s charter or capital structure, raising new financing, making large expenditures or acquisitions, hiring or firing key executives, or entering new lines of business.

As your company grows, investor expectations will shift as well. While early investors were sold on your vision, growth-stage investors are now looking at your ability to execute. They expect to see measurable growth-like revenue growth rates, user acquisition growth, and scalability of the business model. 

One of the ways to maintain healthy relationships with each member of your board or key shareholders in this stage is to cultivate one-on-one relationships. Having periodic casual check-ins with your investor directors can build rapport and trust. It also gives you a chance to sense any concerns early and talk them out so you’re not surprised in the next board meeting. 

Governance in the growth stage can also introduce new challenges, like handling disagreements and balancing differing agendas. As a company leader, you’ll sometimes play the role of mediator to forge a unified direction. Another challenge for entrepreneurs is the mindset change of sharing control. You may occasionally feel frustrated that you “have to ask permission” for things in your company. Try to remember that a good board is there to provide oversight and wisdom from their experiences. 

In later stages, you might find new types of investors joining the mix. Board composition in late stage tends to include a mix of company representatives, investors, and independent directors with industry or public company experience. If you’re still running the day-to-day at this stage, you’ll likely be sharing the table with people who have run large businesses or have been on many boards before.

Decision-making at the late stage is highly structured. There may be subcommittees of the board (audit committees, compensation committees, etc.), especially if an IPO is on the horizon. Reserved matters are still in play, although by now, most big decisions automatically involve the board anyway. The key for entrepreneurs is to understand that late-stage investors are typically exit-oriented - they are optimizing for a successful exit (IPO or sale) within a relatively short timeframe. They will be very focused on metrics that public markets or acquirers care about - revenue growth, profitability, efficient operations, market share - and more cautious of quick decisions or experiments that were common in the growth stage.

For entrepreneurs, managing board relationships in the late stage often means truly embracing the role of a mature CEO - or knowing when to transition to another role. If you are staying on as CEO, acknowledge that running a late-stage company is a different job than running a startup. You may need to lean much more on your senior team and act more as a coordinator and communicator to the board. 

Continue to nurture individual relationships and be receptive to the board’s suggestions, which might include making tough decisions that stand in contrast to the ones you would have made when your company was younger. At the same time, don’t lose your early-stage passion—you still carry the company’s vision, and that perspective is invaluable in strategic discussions. The board needs to hear your vision for the long-term, even as they think about the exit, so they can make balanced decisions.

Best practices for healthy shareholder and board relationships

While each stage has its nuances, these guiding principles apply throughout your company’s growth journey. Here are some best practices to foster healthy and effective communication with your investors and board:

Common challenges and red flags to watch for

Lastly, let’s highlight a few common pitfalls that entrepreneurs should watch out for in shareholder-board relations:

Good corporate governance isn’t just a “nice to have” - it’s fundamental to growing your company with the right stakeholders to support you. In this article, learn how your relationships with stakeholders can change over time and key tips to foster healthy relationships. 

How to manage your stakeholder relationships as you grow

If you’re planning to acquire a private company, you may be asking yourself, “How will I pay for the business?”

This seemingly simple question is one of the most important decisions you’ll make as an acquirer. The structure of your financing - called your capital stack - directly impacts the financial stability, flexibility, and 

 of your target business. Poor structuring can lead to excessive leverage, covenant breaches, or misaligned incentives among stakeholders, which can ultimately erode returns and create additional challenges when growing your business.

In this article, we’ll explore what a capital stack is, discuss the balance of risk and return between different financing sources, and break down each component to highlight what acquirers should watch out for when crafting their capital structure.

Balancing the risk and reward of your capital stack

Building the right capital stack for your transaction is essential for 

while managing risk and safeguarding against potential pitfalls. 

This delicate balance requires a thorough analysis of the target’s cash flows, asset quality, and market conditions to ensure that the investment opportunity has enough 

, yet does not overburden the company during adverse periods. 

Ultimately, achieving this equilibrium aligns the interests of all stakeholders, minimizes default risk, and lays the foundation for robust financial performance across varying economic cycles.

Breaking down each component of your capital stack

The right capital stack goes beyond managing risk and choosing the right 

. Each component of your capital stack has distinct characteristics that can influence your day-to-day business decisions, your strategic planning, and the company’s performance.

Below, we’ll explain the key components of a capital stack and highlight the distinct characteristics of each that you should consider when planning your acquisition.

 reserves the highest priority to be paid back in the event of a liquidation. This debt is secured by company assets and typically carries the lowest interest rate due to its low-risk nature and strict repayment obligations.

 Assess whether the rates are fixed or floating, and understand how market conditions might affect them.

 Be aware of arrangement fees, commitment fees, and other associated costs.

 Determine if the debt is fully amortizing or has a bullet maturity, and ensure that repayment terms align with projected cash flows.

 Evaluate the likelihood of needing to refinance at maturity and the potential impact of changing market conditions.

 Monitor metrics such as Debt Service Coverage Ratio (DSCR), leverage ratios, and EBITDA thresholds.

 Understand any limitations on additional borrowing, dividend distributions, or asset sales.

 Identify which assets are pledged and understand the implications in the event of an economic downturn or bankruptcy.

 Know whether lenders have access to the parent company’s other assets in a default scenario.

Subordinated debt and mezzanine financing

 debt is considered junior debt, sitting just below senior debt in repayment priority in the event of a liquidation. Suborindated debt is accompanied by higher interest rates, whlie 

 acts as a “hybrid” debt security with equity-like features, such as warrants or convertible options, to compensate for its increased risk.

Consider these aspects when building your capital stack:

 Recognize that subordinated debt and mezzanine financing typically carry a higher cost relative to senior debt.

 Consider if interest accrues rather than being paid in cash, which could impact cash flow.

 Be mindful of features that offer lenders upside potential but might dilute equity if exercised.

 Clearly understand the lender’s position in the repayment hierarchy.

 Although mezzanine debt is often less restrictive than senior debt, it may still come with covenants that affect strategic decisions.

 Be aware of any conversion or early redemption features that could influence the timing or structure of your exit.

Equity can either come from investor capital or from the sponsor (acquirer) themselves. This component of an acquisition is typically small relative to the amount of debt used in a transaction (ie, a 

 Recognize that equity typically represents only a fraction of the total purchase price, impacting the overall risk/return profile.

 Consider setting up management equity or incentive pools to align interests post-acquisition.

 Look for provisions that grant board representation, veto rights on major decisions, or protective provisions in adverse scenarios.

 Understand the distribution structure on exit, including any preferred returns, clawback provisions, or dilution protections.

 Evaluate how these preferences might affect the return distribution upon exit, especially in downside scenarios.

 Factor in the tax implications of different equity structures and their impact on net returns to LPs and sponsors.

Learn how buyers finance an acquisition and what to keep in mind when considering capital sources.  

Key considerations for your capital stack

In a leveraged buyout, a buyer - commonly a private equity firm - acquires a target company by placing a substantial portion of the purchase consideration onto the target’s balance sheet as debt. The buyer then uses the target’s future cash flows or assets as collateral to service and eventually repay this debt.

LBOs became particularly popular in the 1980s with groundbreaking deals like the acquisition of RJR Nabisco by private equity firm, KKR. In today’s market, they remain a staple in private equity strategies, ranging from small, niche acquisitions to multi-billion-dollar transactions.

LBOs are attractive financing structures for private equity firms because the use of debt to purchase a company can significantly amplify investors’ return on equity (ROE) -typically measured by the 

This structure also enables private equity firms to invest less of their own - and their investor’s capital - into a deal, allowing firms to fund and operate a larger set of companies than they would have been able to by financing each acquisition with only equity. Spreading out their capital leads to diversification for the firm and its investors, allowing them to gain exposure to more companies and industries.

Executing an LBO requires robust due diligence and financial modeling to account for the risk profile of using significant debt for an acquisition. A private equity firm will typically follow the below steps in order to successfully close on an LBO transaction and operate the business to a successful exit. 

While we know that LBOs use a high level of debt as part of the capital stack of a deal, not all debt has the same characteristics. Firms combine a variety of debt and equity sources to fund an LBO which can generally be broken down into the following categories:

Investors who may be considering participating in a firm’s leveraged buyout transaction should carefully consider specific company, market, and operator factors that could positively or negatively influence the outcome of the deal. Here are some to keep in mind:

Zest is digitizing private market transactions, building tools to streamline how entrepreneurs, funds, and investors transact. Our platform is designed to save you time, reduce administrative costs, and bring transparency to your deal process. Whether you’re exploring your first LBO or looking to expand your portfolio with another, our technology can simplify documentation, execution, and post-acquisition reporting.

A leveraged buyout (LBO) is a financial transaction in which a company (the “target”) is acquired using a significant amount of borrowed funds. In this article, we’ll explore how an LBO works, why private equity (PE) firms and other investors use this strategy as well as the risks involved.

What is a leveraged buyout (LBO)?

When a private market M&A transaction occurs, it may seem that the buyer and seller of the target company easily agree on the business’s valuation. 

After all, we’ve all seen headlines that read, “Company X acquired by [insert buyer name] for $250M.”

However, settling on a valuation is far from simple. Each party typically has their own interpretation of what the business is worth—sellers may be overly optimistic with their valuation, while buyers want to pay the lowest price. To address this challenge, buyers and sellers often use what’s called an “earnout”— a contractual mechanism that can help bridge the gap between what a buyer is willing to pay for a business and what the seller is willing to sell for.

In its simplest form, an earnout is a provision in an acquisition agreement that ties a portion of the sale proceeds to the future performance of the acquired business. 

Instead of paying the full purchase price upfront, the buyer agrees to make an initial payment to the seller, followed by additional payments over time based on the company meeting certain pre-determined performance targets—commonly tied to revenue, EBITDA, or profit milestones. 

Earnouts allow the buyer to mitigate the risk of overpaying for a business while enabling the seller to earn future compensation, maximizing the value of their sale—a compromise for both the buyer and seller.

Earnouts are primarily used to address the gap between the buyer’s and seller’s proposed valuation for the business being transacted. 

Earnouts are particularly common when a business is at a growth stage or relies on unproven products and markets. Specific industries may impact the use of an earnout as well—life sciences, biotechnology, and other research and development (R&D)-heavy industries where progress may be contingent on a clinical trial or regulatory approval can use an earnout structure to tie compensation to the success of those milestones. 

Earnouts have become more common over the years. In a recent 2024 study, they

By using an earnout, both parties share the risk involved in a transaction. If the company performs in line with the seller's predictions, the seller reaps the reward. If it underperforms, the buyer avoids overpaying.

Earnout agreements can involve lengthy negotiations between the buyer and seller, making the final structure of an earnout more of an art than a science. However, a few key components make up most earnout structures. 

: Any earnout agreement must be anchored by certain performance metrics or key milestones. 

Roughly two-thirds of earnouts are based on the company reaching certain 

, while 23% are based on EBITDA targets. Business sellers generally prefer to use revenue targets to invest resources into growing top-line revenue, while business buyers lean toward EBITDA targets, prioritizing efficiency and profitability. 

Other key milestones that earnouts may be based on can include unit sales, product launches, divestiture of assets, customer acquisition rates, or certain regulatory approvals. 

: Earnout agreements can spread payments over a set number of months or years after the initial acquisition, commonly between 1-3 years. As for the amount of the earnout, most deals tie earnout payments to a range of 10-30% of the total business purchase price.

Payments to the seller might be made annually or triggered once certain milestones are met—which can either be a single payout or a tiered payout structure. Importantly, the agreement should outline how these metrics are measured, verified, and reported, particularly as the conditions are increasingly complex.

: Clear, transparent reporting is critical to avoid disputes. Earnout agreements should specify how performance will be measured—whether through audited financial statements, external third-party verification, or internal metrics approved by both sides as well as the accounting standard being used. 

Sellers often require detailed information rights in the transaction documents to ensure they are able to stay up-to-date on the progress of achieving their earnout targets. 

Negotiating and drafting an earnout agreement

A well-structured earnout starts with a clear alignment between the buyer and seller on the performance targets and reporting methods to measure success. Beyond the basic components of an earnout, these agreements should include additional covenants detailing who has decision-making authority over the business and how to resolve disputes. 

Naturally, business sellers want to retain as much control as possible over the decisions to maximize their likelihood of reaching their targets. Sellers typically request that the buyer support the business's endeavors financially to help the business succeed. On the other hand, buyers may seek control over certain business decisions as they are eager to execute their vision.

Including covenants for resolving disputes is also wise—often called an “alternative dispute resolution” (ADR) provision. This might involve an independent auditor, arbitration, or a pre-agreed formula for adjusting targets if market conditions evolve beyond anyone’s control. In rare circumstances, disputes over the scope of this provision have led to litigation between the two parties. However, with proper planning and detailed earnout agreements, you can reduce the chances of serious misalignment. 

Earnouts can be a powerful tool to close the valuation gaps between buyers and sellers, addressing the risk that can arise from information asymmetry in a private market transaction. 

Buyers and sellers can compromise and increase the chances of a successful transaction by tying part of the purchase price to measurable post-close performance metrics. However, both parties should ensure that their expectations of the earnout structure are communicated with each other and detailed in the transaction documents to avoid lengthy or expensive future disputes. You should work with your counsel early on in the process to assist with creating your earnout agreement.

Earnouts can help bridge the gap between a buyer’s and seller’s valuation in an M&A transaction. In this article, we break down everything you need to know about this contractual mechanism.

What is an earnout in M&A deals?

While the investment performance of public market funds offers clear performance indicators backed by frequent liquidity and transparent reporting, the performance of private market funds is typically more nuanced. 

Within private markets, performance indicators must account for the unique timeline of value creation in private companies, the fundamental differences of an illiquid environment, and the sparse availability of updated valuations and performance information. 

In this article, we’ll discuss the lifecycle of value creation among private companies, how investment funds report on valuations, and why certain performance metrics are used over others.

The lifecycle of private fund performance 

Publicly traded stocks are traded and valued throughout the day; however, the same isn’t true for private companies. 

A private company's maturation may take years to bear fruit, as it takes time to find 

, grow its customer base, and increase revenue. Company 

 are only updated occasionally through new fundraising rounds, secondary sales, or exit opportunities like an acquisition or initial public offering (IPO). 

This timeline of financial performance across private companies is, therefore, reflected in the investment performance lifecycle of private funds. 

,” which shows that a private fund's performance in the early days is often negative as capital is called from investors and invested into a fund’s first portfolio companies. During the first few years of a fund’s early investments, management fees are being charged by the fund without seeing any valuation increases. 

Only over time, once companies begin to see company valuation changes, does the slope of a fund’s J-curve turn positive. In private markets, most realized investment gains occur during the fund’s harvesting period, which occurs in years 7-10 and beyond. 

: IRR measures an investment’s annualized return and considers the timing and magnitude of unrealized valuation markups (“Unrealized IRR”) or cash flows (“Realized IRR”). 

IRR can be reported as gross IRR—the investment’s return before management fees, fund expenses, and carried interest are deducted—or net IRR—the return after all fees, expenses, and carried interest are deducted. Net IRR is what investors actually receive from their investment and is therefore considered a better picture of their investment return than gross IRR. 

: MOIC is a simple calculation that reflects a portfolio's unrealized and realized gains as a multiple of your initial investment. Importantly, MOIC is a multiple of your total investment, not just the capital that has been called. 

This figure is expressed using a number followed by “x” to indicate how many times the current value is compared to your initial investment. MOIC is measured on an absolute basis rather than time-weighted, like IRR. 

: TVPI is a calculation similar to MOIC that measures a portfolio's total (unrealized plus realized) gains, with one key distinction. 

Rather than being a multiple of the total invested capital, TVPI is a multiple of paid-in capital—which is the amount of capital an investor has contributed or has been called by the manager at any given time. While capital is being called, TVPI is greater than MOIC. However, once all capital has been called, the “paid-in” amount matches the amount of total invested capital, making TVPI and MOIC identical on a gross or net basis. 

: DPI is often used in conjunction with its TVPI counterpart. However, rather than measuring the total gains in a portfolio, DPI only considers investor distributions. 

DPI is measured as a multiple of paid-in capital, which, like TVPI, increases over time as the fund calls investor capital.

Each performance metric considers different variables in its equation and has different use cases for when it’s the most relevant.

Given its time-weighted nature, IRR is most commonly used in traditional private equity and late-stage venture capital deals. Funds in this market segment seek investor returns within a shorter time horizon and use IRR to compare both the size and timing of returns. 

Performance metrics like MOIC, TVPI, and DPI are more often seen in early-stage venture capital funds as these ignore the impact of the timing of returns and instead focus on the magnitude of returns. Earlier-stage funds can have long holding time horizons. Therefore, they seek larger absolute multiples on their initial invested capital or paid-in capital. 

For some investors, DPI is favored as it measures true investor distributions rather than unrealized markups. Historically, exuberant market conditions have resulted in large unrealized markups but failed to deliver investor distributions, ultimately leaving investors with no realized gains. As a result, DPI has grown in popularity among investors who seek to understand their take-home returns. 

Regardless of the specific asset class a fund invests in, most funds report several of these metrics when presenting their investment performance. Investors can review the different metrics and draw their own conclusions regarding the fund's strengths and weaknesses. 

Investment performance can be categorized by distinct vintage years—the year the fund started making investments—as well as fund size, geography, asset class, and industry. These are common differentiating factors between funds, as each of these characteristics impacts the opportunities and challenges a fund manager faces in investing capital. 

Over time, macroeconomic conditions, including inflation, interest rate changes, and geopolitical risks, can also impact fund performance.

Lastly, even different funds managed by the same fund manager can vary dramatically given economic conditions, the availability of attractive investment opportunities, and their selection of certain investment opportunities. 

Zest is digitizing private market transactions, building tools to streamline how entrepreneurs, funds, and investors transact. Our platform is designed to save you time and reduce administrative costs, simplifying the end-to-end investment process.

Private equity and venture capital funds report on their investment performance using various methods. An investor must understand how each method is calculated and what to watch out for when reviewing a fund’s performance.

How to measure the investment performance of a private market fund

If you’ve ever made a deal with someone and you weren’t sure that they were going to follow through with their end of the arrangement, then you know why escrow providers exist. 

Historically, this is how most financial transactions were made — a buyer or investor would wire funds to the seller or issuer without complete confidence that they would hold up their side of the bargain and that their representations during due diligence were truthful and accurate. 

As a result, any participant in a private market transaction would be subject to meaningful 

Today, this risk is limited by using an escrow provider during a transaction. An escrow provider is a type of company that acts as a neutral third party in private market transactions to hold certain funds related to the transaction until both sides meet their contractual obligations in the deal. 

In addition to mitigating counterparty risk, escrow providers introduce many transaction-related benefits to stakeholders, such as custodying funds before dedicated bank accounts are set up or if a transaction is delayed for ongoing negotiations or simply for procedural reasons. 

Years ago, financial transactions were handled offline, in person — with the buyer and seller meeting to close the deal and transfer funds. However, as transactions became digitized and buyers and sellers started transacting from different parts of the world, the need for escrow services surged.

As a response to the developments in private market transactions, regulatory bodies followed suit and created rules governing who can provide regulated escrow services, as well as what processes and controls such service providers need to have in place, bringing compliance and transparency to the ecosystem. 

Private market participants benefit from using an escrow provider, particularly given the inherent fragmentation and opacity in private market transactions. 

Escrow providers can help bring transparency, confidence, and standardization to each deal, allowing parties to focus on the merits of the deal itself, rather than either side keeping their word. Depending on the type of transaction and which financial partners are involved, it may be required to use an escrow agent.  

Private companies and investment leads (such as venture capital funds, private equity funds and family offices) use escrow providers when raising capital from investors. In either case, the escrow provider is typically hired by the issuer—i.e., the party raising capital—and custodies the investor’s commitments until the issuer's obligations are met, at which point the escrow provider can transfer the investor’s funds to the issuer. 

Escrow agreements in private capital raises are a set of documents that stipulate which conditions must be met in order for the escrow funds to be transferred to the receiving party. Most commonly, an escrow agreement will define the minimum amount of capital that the issuer must raise before investor funds are transferred to them. This contingency can also be accompanied by the escrow agent’s responsibilities, the timeframe for the issuer to raise investor capital, and due diligence contingencies. These stipulations instill confidence in investors — particularly those who write smaller checks or ones who commit funds early in a fundraising process — as they know their investment will be returned if the issuer can’t raise the amount they need to execute on their plans. 

On the issuer’s side, and especially in the case of newly established entities or those creating holding companies for the purpose of the transaction, this may also be beneficial as a means to gather the funds until they are able to open a bank account. A process which often takes some time to complete.

In M&A transactions, an escrow provider is used to ensure that both sides of the transaction are truthful in their representations and are acting in good faith throughout the process. Three common use cases for escrow providers in M&A transactions include:

Ultimately, an escrow provider serves both sides of a transaction to facilitate a clean and transparent deal, while providing downside risk to each party and ensuring that all stakeholders are acting in good faith. Some key benefits of using an escrow provider include:

Zest is digitizing private market transactions, building tools to streamline how entrepreneurs, funds, and investors transact. Our platform is designed to save you time, reduce administrative costs, and bring transparency to your transaction process. 

Using an escrow provider in your private market transaction can improve transparency between each side and reduce counterparty risk. Find out what exactly an escrow provider does and key use cases for having one.

Benefits of using an escrow provider

Entrepreneurs and their early teams face many challenges while starting and growing their businesses. One of the most significant challenges is testing your initial hypothesis, shipping an early version of your product, and measuring customer feedback.

Before scaling, you need to understand if there is demand for your product. Do people want what you’re building at the price you’re selling it at? 

Startups refer to this as “product-market fit.” And today, we’ll break down what you need to know about finding and measuring product-market fit, and what achieving product-market fit could mean for your business. 

There is no single definition of product-market fit. Marc Andreessen, the co-founder of Andreessen Horowitz who is credited for initially drawing attention to this matter, said in his 

, “Product-market fit means being in a good market with a product that can satisfy that market.”

In practice, product-market fit means there is a real market demand for your product and people are willing to purchase your product at the price it is offered. This is a sign that customers derive greater value from using it than the price of it, or that it’s a better solution than alternatives on the market. 

Product-market fit makes customer acquisition easier because existing customers tell their friends about your company, and new customers sign up. This is fundamentally the most crucial aspect of building a company. 

Why is product-market fit (PMF) important for your business?

Finding product-market fit is critical for your business before you decide to invest more resources into building products that people may not want.

Once you understand that there is a market demand for your product, your teams across sales, marketing, product, and customer support can all move in the same direction, supporting customers and building experiences that people want. 

On the contrary, failure to find product-market fit can lead to your company running out of money and shutting down. CB Insights found that this was the reason approximately 35% of startups fail in their 

How do you find and measure product-market fit (PMF)?

Finding product-market fit can be a journey through many rounds of customer feedback and product testing.

The main goal is to collect the information necessary to deeply understand your target customer’s pain points and how to solve those pain points at the right price. 

When you’re first starting, it’s common to test your initial hypothesis with customer research, surveys, and feedback from stakeholders in the industry. This data gathering can allow you to begin building an MVP based on the feedback you’ve received. Once you have an MVP built, you can track how your customers respond to your product to understand what users actually do when given the choice to interact with your product. 

Sean Ellis, entrepreneur and startup advisor, says that a strong indicator of product-market fit is asking your customers “How would you feel if you could no longer use the product?” If the percentage of respondents who answer “very disappointed” is over 40%, that is a strong indicator of achieving product-market fit.

Qualitatively, your customers should be obsessively using your product. A strong sign of product-market fit is having customers who praise your new product and refer their friends to sign up. If your customers eagerly utilize your product because they understand exactly the problem that it’s solving, you know there is a real market demand that’s present.

Other ways to measure product-market fit include tracking usage metrics from your customers, including retention, engagement, and conversion rates for upsell opportunities. 

What can product-market fit (PMF) mean for a scaling business?

Product-market fit occurs when you satisfy a need in the market and customers are willing to pay for your solution. Learn more about how you can find product-market fit and what this can mean for private companies. 

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