GG Thinks: Liquidation Preferences: Scenes from a Marriage with Portuguese Law

In venture capital transactions, liquidation preferences shape downside protection, redistribute risk between founders and investors, and determine the economic logic of the investment itself. This mechanism helps mitigate the risk that the company was incorrectly valued at the time of investment. While this is a significant risk management tool for investors, it can create problems when things go wrong: if the value of the common equity falls below the liquidation preference, founders may find themselves without sufficient incentive to remain committed. These potentially diverging interests mean that one party may eventually challenge the terms — even if litigation remains a rare occurrence in venture deals.

In this think-piece we’ll examine how liquidation preferences operate within Portuguese corporate law, from liquidation and sale-of-control scenarios to mergers, and identifies the key structural questions practitioners should consider.

In common law jurisdictions, liquidation preferences are governed under a corporate law framework that affords significant contractual flexibility for all parties. In Portugal, however, the clause sits within a more formalistic regime governing asset distribution and corporate rules in general, share transfer restrictions and shareholder binding mechanisms.  This does not mean that liquidation preferences are incompatible with Portuguese law. Rather, their scope and enforceability depend on how they are structured and the legal instrument in which they are placed. Nonetheless, the whole extent of the economical function intended by the parties can be achieved in Portugal, through adapting the mechanisms used to the law in force.  

What Is at Stake

Liquidation preferences grant holders of a particular class of shares priority to receive a predetermined amount upon a liquidity event — typically a sale, merger or liquidation. That amount commonly corresponds to either 1x the invested capital, or a multiple (2x, 3x, etc.) of such amount.

In addition, it may be structured as (i) non-participating, case in which the investor receives either the preferential amount or the pro rata share as an ordinary shareholder, whichever is higher; or (ii) participating, in which the investor first receives the preferential amount and then participates pro rata in the remaining proceeds.

Our analysis focuses primarily on the issues raised by liquidation preference multipliers and by the legal placement of the clause under Portuguese corporate law.

In Portuguese venture-backed companies, these rights are often embedded in the company’s bylaws. However, each triggering event — liquidation, sale of control, merger — raises distinct questions under the Companies Code (CSC). A careful analysis requires separating these scenarios.

1. Liquidation: The Limits of Priority

Upon liquidation, once creditors are satisfied, the remaining assets are allocated, first and foremost, to repay shareholders for the contributions effectively paid in. Pursuant to Article 154 of the Portuguese Companies Code (CSC), all of the company’s liabilities must be settled before any distribution of assets may be made. This includes not only liabilities owed to third parties, but also liabilities owed to shareholders, including those arising from supplementary contributions, ancillary contributions and shareholder loans. After that, under Article 156(2) of the CSC, the first allocation of the remaining assets is the repayment of the amount of the paid-in capital, without prejudice to any provisions in the company’s bylaws regarding cases in which shareholders have made contributions exceeding their proportion of the share capital. In other words, this exception covers situations where shareholders have subscribed contributions with a share premium, allowing the company’s bylaws to permit the return of such premium at this stage. Article 302 further permits differentiation between classes of shares regarding the distribution of liquidation proceeds.

At first sight, this suggests room for structuring preferential rights. Indeed, where liquidation preference is limited to 1x the invested capital (including share premium), on a non-participating basis, the solution appears relatively uncontroversial: the bylaws may legitimately establish priority in repayment of the paid-in contributions.

The difficulty arises when the clause provides for a multiplier greater than 1, or for a 1x preference with participation. At that point, the core question is whether shareholders are free to establish, in the bylaws, repayment rights exceeding the total value effectively contributed by the preferred shareholder – that is, nominal capital plus share premium.  

The issue can be illustrated with a simple example.

A company has share capital of €500,000. A preferred shareholder contributes €100,000 nominal value plus €300,000 in share premium. The bylaws establish a 2x liquidation preference. After creditors are paid, €800,000 remains available for distribution to shareholders.

Is the preferred shareholder entitled to receive the full €800,000 — twice the total contribution — before any distribution to other shareholders? Or is priority limited to repayment of €400,000 (nominal value plus share premium), with the remaining €400,000 distributed among the other shareholders in accordance with the rules governing the distribution of the residual assets?

The answer depends on how one interprets the final part of Article 156(2).

That provision states, in essence, that the remaining assets are first allocated to the repayment of the contributions effectively paid in, without prejudice to what the articles may provide where a shareholder’s contribution exceeds the nominal value of its participation.

One reading emphasises contractual autonomy. The provision states that the default repayment rule applies “without prejudice to what the contract provides” where contributions exceed nominal value. It does not explicitly cap repayment at the amount contributed. Combined with Article 302, this may support the view that differentiated economic rights — including enhanced priority — are permissible.

A stricter reading, however, emphasises the statutory structure. The law expressly mentions flexibility only where contributions exceed nominal value. From this perspective, the legislator may have intended to allow preference up to the total effectively contributed – nominal shares plus premium -  but not beyond. A different interpretation could lead to the paradox that even a minimal share premium might justify a liquidation entitlement far exceeding the amount actually contributed, while shareholders who contributed only nominal value would remain limited to that amount.  

The statutory text does not definitively resolve this tension. Nor has Portuguese case law or doctrine handled any situation similar to these.

What emerges, therefore, is a genuine interpretive risk. Where liquidation preferences exceed the invested capital, their enforceability in a winding-up context may depend on whether the clause is read as fully valid or, instead, reduced to the amount effectively contributed by the preferred shareholder.  

2. Sale of Control: Transfer Restriction or Shareholder Obligation?

In practice, liquidation preferences are more often triggered by a sale of control than by formal liquidation.

When the clause is embedded in the bylaws and requires that sale proceeds to be distributed according to a preferential waterfall — rather than through equal price-per-share consideration — a structural question arises: does this constitute a limitation on the transfer of shares?

Article 328 of the CSC allows certain restrictions on the transfer of registered shares, provided they are determined, objective or subjective, and aligned with the corporate interest.

If liquidation preferences are characterised as a transfer restriction, their validity depends on whether they satisfy these requirements.

One view holds that, where the inclusion of liquidation preferences was a necessary condition for the initial investment, it serves the corporate interest by enabling capital formation. Under this approach, structuring sale proceeds according to a preferential waterfall is consistent with the company’s interest.

A competing thesis argues that such clauses protect only the economic position of preferred shareholders and do not serve the company as such. On that reading, they may exceed what is permissible as a statutory limitation on transferability.

Alternatively, liquidation preferences in sale scenarios may be conceptualised not as a transfer restriction but as a payment obligation among shareholders arising upon sale. In that case, the clause operates outside the sphere of the company itself and should be anchored in a shareholders’ agreement pursuant to Article 17 of the CSC. If located solely in the bylaws, it risks being inoperative.

Whichever characterisation one adopts, the practical implication is clear: reliance exclusively on inclusion in by-laws is insufficient. Reinforcing liquidation preference mechanisms in a shareholders’ agreement ensures that binding obligations exist between the relevant parties, reducing uncertainty as to enforceability.

3. Merger: Structural Constraints and Strategic Leverage

Mergers introduce additional complexity.

Article 97(5) of the CSC limits the cash component that may be attributed to shareholders in a merger to 10% of the nominal value of the shares allocated. In venture-backed companies, nominal value is often marginal relative to invested capital.

If liquidation preferences are structured as a direct cash entitlement upon merger, this statutory cap may render them largely ineffective in economic terms.

An alternative structure may link preferential rights to the issuance of new shares, valuing those shares at market value for distribution purposes. In this scenario, the amount due ‎to each preferred shareholder would be converted into an equivalent number of shares by reference to such market value. Such design requires careful drafting and anticipation of how the preference is triggered.

At the same time, embedding preferential rights in the bylaws may strengthen investor protection. Under Article 103(2)(b), the registration of a merger requires consent from holders of special rights whose position is affected. This procedural safeguard can provide meaningful leverage to preferred shareholders where the merger terms risk diluting or disregarding their preferential position.

Thus, while inclusion in the by-laws may introduce certain constraints, it may also confer strategic advantages.

Beyond the Multiplier

Debate around liquidation preferences often centres on its economic parameters — 1x versus 2x, participating versus non-participating.

Under Portuguese corporate law, however, the decisive issues are structural.

The key questions are:

• Is the clause located in the bylaws, a shareholders’ agreement, or both?

• Does it interact with mandatory distribution rules in liquidation?

• Could it be characterised as an impermissible restriction on share transfers?

• Who is legally bound, and by what mechanism?

Portuguese corporate law allows contractual autonomy, but within a framework that is more formalistic. Treating liquidation preferences as a simple transposition of foreign market practice risks overlooking these structural differences.

As the Portuguese startup ecosystem continues to grow — and as distressed exits and disputes inevitably emerge — these clauses will be tested. Judicial clarification will shape future drafting practices.

For now, one conclusion can be drawn with some confidence:

The compatibility of liquidation preferences with Portuguese law depends less on the mathematical formula for calculating the preferential rights and more on its legal architecture — where it is placed, how it is drafted, and how it binds shareholders.

This challenge is not unique to Portugal; it is present across continental Europe, where corporate law frameworks differ significantly from common-law jurisdictions and where many of these questions remain untested in practice¹.

Even where placing the liquidation preferences in the articles of association carries interpretive risks, these can be mitigated through a functional equivalent: a binding agreement among shareholders that effectively governs the same economic mechanics. While such an instrument does not bind third parties in the way the articles of association do, it remains fully enforceable among the shareholders who adhere to it and can be drafted to replicate, with precision, the operative rules of the liquidation preference. A well-structured shareholders’ agreement binding all shareholders ensures that each of them is contractually obliged to comply with the agreed waterfall and related provisions and incurs civil liability in the event of breach. In practice, this allows the parties to achieve clarity, enforceability and alignment of expectations, even where the statutory route may present uncertainties.

This demonstrates that, in Portugal, the legal framework is not an obstacle to venture capital practice: it is simply a matter of selecting the appropriate contractual instruments and ensuring that the agreed mechanisms bind all parties effectively.

In venture capital, precision in economic modelling is taken for granted. Under Portuguese law, equal precision is required in legal design.

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Inês Nabais do Paulo | Associate in Corporate, Employment and Regulatory Law

Afonso Almeida Luís | Junior Lawyer

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