Participating preferred stock is a type of Preferred Stock issued by startup companies to investors, providing them with preferential rights and privileges in the event of a company sale or liquidation event. It grants investors both a liquidation preference and the ability to participate in the distribution of remaining proceeds.

In the event of a company sale or liquidation, participating preferred stockholders generally have the right to receive their initial investment amount (liquidation preference) before common shareholders. Additionally, they have the opportunity to participate in the distribution of any remaining funds or assets on a pro-rata basis, along with common shareholders.

The participation feature allows participating preferred stockholders to potentially receive higher returns on their investment. Once they have received their liquidation preference, they can convert their preferred shares into common shares and share in the distribution of the remaining proceeds based on their ownership percentage. However, this participation can dilute the value available to common shareholders.

Participating preferred stock terms, including the specific liquidation preference and participation rights, are outlined in the stock's governing documents. It is important for both investors and startup companies to carefully negotiate these terms to ensure fair and aligned interests. Seeking legal and financial advice is recommended to navigate the complexities of participating preferred stock and its implications for all parties involved.