How a Waterfall Analysis Distributes Exit Proceeds

A waterfall analysis calculates the distribution of exit proceeds across all shareholders and instrument holders at a defined exit value, applying liquidation preferences, participation rights, and anti dilution adjustments in the correct order of priority for each share class. The analysis must be run across a range of exit values, not at a single point, because the distribution pattern changes as the exit value crosses preference return thresholds and conversion points. A minimum of ten exit scenarios is required for Level 2 compliance under the FFI Standard.

The most common error is running the waterfall at a single optimistic exit value and presenting the result as if it represents the full picture. At that exit value, every class may appear to receive a proportional return. At a lower exit value, the preference structure concentrates proceeds among preferred shareholders in ways that materially change the founder's outcome. Both scenarios should be modeled and understood before any new instrument is issued.

RELATED TERMS
- What a Fully Diluted Cap Table Records
- How a SAFE Note Converts at a Valuation Cap
- What Pre-Money and Post-Money Valuation Mean in a Term Sheet
- The Cap Table as a Source of Truth

Tool: Financial Model Blueprint