Pari Passu: What It Means for Founders, Investors, and Shareholders

Key takeaways

• Pari passu is a Latin term meaning "on equal footing," used in corporate finance and law to establish that two or more claims, securities, or parties hold the same rank and are treated without preference over one another.
• In startup equity, pari passu determines whether multiple investor classes share equal priority for payouts, such as liquidation proceeds and dividends.
• Pari passu liquidation preferences mean all preferred shareholders of equal rank are paid simultaneously from exit proceeds. Stacked preferences, by contrast, pay later-round investors first.
• When exit proceeds are insufficient to cover all pari passu liquidation preferences in full, the available funds are distributed pro rata based on each investor class's preference amount.
• Pari passu and pro rata address different questions. Pari passu establishes equal ranking (who gets paid at the same level). Pro rata establishes proportional allocation (how much each party receives relative to their claim).
• Pari passu clauses appear in shareholder agreements, term sheets, loan covenants, and insolvency statutes. The scope of the clause depends on the specific drafting language.

Pari Passu: What it means for founders, investors, and shareholders

Pari passu is a Latin term meaning "on equal footing." It establishes that two or more parties, claims, or securities hold the same rank and are treated without preference over one another. The term appears frequently in term sheets, shareholder agreements, loan covenants, and insolvency proceedings to define how rights, payments, or claims are prioritized.

For founders, pari passu determines how investors are ranked relative to each other during a fundraising round and, more critically, how exit proceeds are distributed when the company is sold or liquidated. 

A pari passu clause among preferred shareholders means that all preferred share classes of the same rank are treated equally, so no investor within that group receives a payout before another; however, preferred shareholders as a whole still rank above common shareholders.

Understanding how pari passu functions across different contexts, and how it differs from pro rata, is fundamental to reading and negotiating investment documents accurately.

How pari passu works

The operational meaning of pari passu depends on the context in which it appears. 

Pari passu in equity and shareholder rights

When a company raises capital, it issues preferred shares to investors. Pari passu clauses specify that certain preferred share classes rank equally with each other during liquidation or exit events, so they share proceeds proportionally rather than one being paid before another.

Within a single funding round:

When multiple investors participate in the same funding round and receive the same share class, they already rank equally by default.

For example, if three investors each hold Series A preferred stock, all three will recover their payout before common shareholders receive anything, and none is paid ahead of the others.

Across multiple funding rounds:

As a company raises multiple rounds (e.g., Series A and Series B), different groups of investors may have competing claims in a liquidity event.

This is when the payout waterfall is applied, and the order of payment becomes critical.

A pari passu clause ensures that:

• Series A and Series B investors share the same level of priority, and
• available proceeds are distributed proportionally between them.

Without this, newer investors (e.g., Series B) may negotiate for senior (or “stacked”) preference. Meaning, Series B is paid in full before Series A participates.

This distinction only becomes meaningful when proceeds are limited—because the order of payment directly determines how much each group actually receives.

Pari passu in debt and lending

In lending, pari passu clauses appear in loan agreements and bond indentures to establish that a particular debt obligation ranks equally with other unsecured obligations of the borrower. A lender who holds pari passu debt cannot be subordinated to another lender of the same class if the borrower defaults.

For example, if a company issues two separate tranches of unsecured bonds and the governing documents specify pari passu ranking, neither tranche of bondholders can claim priority over the other in the event of default. Both groups are entitled to a proportionate share of available repayment, rather than one group being paid in full before the other receives anything.

Pari passu clauses in debt instruments serve as a protection mechanism for creditors. Without such a clause, a borrower could potentially restructure its obligations to favor one creditor group over another, undermining the position of the remaining lenders.

Pari passu in insolvency proceedings

Insolvency frameworks in most major jurisdictions incorporate the pari passu principle as a foundational rule for distributing a debtor's remaining assets among unsecured creditors. 

Under this principle, unsecured creditors of equal rank share the available assets proportionally, based on the size of their claims, rather than on the order in which they filed or the date their debt was incurred.

The principle is codified in statutes across multiple jurisdictions. Under the UK Insolvency Act 1986 (Section 107), property in a voluntary winding up must be applied pari passu among creditors. Under the Indian Insolvency and Bankruptcy Code, 2016 (Section 53), the distribution waterfall for liquidation proceeds follows a statutory hierarchy, where creditors within the same class receive pari passu treatment.

In the United States, the U.S. Bankruptcy Code (11 U.S.C. § 726) establishes the order of distribution in Chapter 7 liquidation, specifying that claims within the same priority class are paid pro rata, which reflects the pari passu principle in application.

Secured creditors, by contrast, hold claims that are backed by specific collateral and are therefore paid ahead of unsecured creditors. Pari passu applies within a given tier of the priority hierarchy, not across tiers.

Pari passu clauses in shareholder agreements and term sheets

A pari passu clause in a shareholder agreement or term sheet specifies that certain shareholders or share classes hold equal rank with respect to defined rights. These rights can include dividend entitlements, liquidation proceeds, voting power, or information rights.

What a pari passu clause governs

The scope of a pari passu clause depends on how it is drafted, but in venture financing it is typically used in a targeted way.

Most commonly, pari passu language applies to specific economic rights that involve ranking, such as liquidation priority. 

Other rights—such as anti-dilution protection, board representation, and consent rights—are not usually governed by pari passu. These are negotiated and defined independently in the transaction documents and may differ across investor groups regardless of their liquidation ranking.

For founders, this distinction matters. If Series A and Series B are pari passu for liquidation, they share proceeds at the same priority level. However, Series B investors may still have stronger protections or control rights because those terms are separately negotiated.

How pari passu interacts with liquidation preferences

Liquidation preferences define how much an investor recovers before other shareholders during an exit. When multiple investor classes hold liquidation preferences with pari passu ranking, they share the available proceeds proportionally based on the size of their respective preferences.

Consider a company with two investor groups. Series A investors contributed $2 million with a 1x liquidation preference. Series B investors contributed $5 million with a 1x liquidation preference. Both classes rank pari passu.

If the company is acquired for $4 million (less than the combined $7 million in preferences), neither group is paid in full before the other. Instead, available proceeds are split proportionally: Series A receives approximately $1.14 million ($4M × $2M/$7M), and Series B receives approximately $2.86 million ($4M × $5M/$7M). Common shareholders receive nothing.

If investor classes have different liquidation multiples, pari passu treatment still applies, but proceeds are distributed in proportion to the total preference claims (investment amount multiplied by the applicable preference multiple), rather than the original invested capital alone.

Pari passu vs stacked preferences

Not all liquidation preferences are structured on a pari passu basis. The alternative is a stacked (or senior) preference structure, where later-round investors receive their liquidation preference in full before earlier investors recover anything.

In a stacked structure, a Series C investor would be paid before Series B, and Series B before Series A, creating a sequential priority waterfall. The practical effect is that earlier-stage investors, despite having taken on more risk at an earlier point in the company's development, receive their proceeds only after later-stage investors are fully satisfied.

The distinction between pari passu and stacked preferences is one of the most consequential terms in a startup's capitalization structure. Pari passu treatment aligns investor incentives more evenly across funding rounds, because no single round's investors can claim seniority over another. Stacked preferences, by contrast, concentrate downside protection in later rounds, which can significantly reduce early-stage investor and founder payouts in modest exit scenarios.

Founders negotiating term sheets should identify whether new investors are requesting pari passu or stacked preferences, because the choice directly affects the waterfall distribution at exit.

Pari passu vs pro rata: What is the difference?

Pari passu determines ranking, which answers: "Who gets paid at the same time?" Pro rata determines allocation, which answers: "How much does each party receive relative to their stake?"

Pari passu establishes that two or more claims hold equal priority. It does not, on its own, determine how much each claimant receives. Pro rata provides the allocation formula, distributing an amount proportionally based on each party's share of the total.

The two concepts frequently work together. When creditors hold pari passu claims and the available funds are insufficient to pay all of them in full, the funds are distributed pro rata, meaning each creditor receives a proportional share based on the size of their claim. 

Pro rata also appears independently of pari passu in contexts like pre-emptive rights, where existing shareholders can purchase new shares in proportion to their current ownership, and in dividend distributions, where shareholders receive payments proportional to their holdings.