What does "liquidation preference" mean in relation to preferred stock?

Liquidation preference refers to a provision associated with preferred stock that ensures preferred shareholders have a priority claim on a company's assets in the event of liquidation. This means that if a company is dissolved or goes bankrupt, preferred shareholders are entitled to receive their investment back before any assets are distributed to common shareholders. This priority is crucial for investors as it provides a layer of security to their investment, reducing the risk associated with potential losses when a company faces financial difficulties.

Preferred stockholders typically do not have voting rights (which distinguishes them from common stockholders), and while dividends may be guaranteed or cumulative, they are not always fixed. The concept does not relate to claims on new equity issues but rather focuses on the order of claims in a liquidation scenario. Thus, the definition of liquidation preference accurately captures the essence of what it entails for preferred shareholders in a corporate context.