Liquidation preferences are very common although there are a wide variety of structures for these, some of which you should run away from, and others that are reasonable and should not cause much (if any) anguish.
We wrote an extensive post on this at CapGenius.com and will include the text from this article below. There are examples with charts and spreadsheets in the post, so we are leaving that part out of the text below, but what is included covers what you need to know.
Here is the link:
And here is the text from the article:
The words “Participating Preferred” are perhaps the most feared, reviled and misunderstood words that can appear in a venture capital (or angel) term sheet. This post will not get into whether a company should accept some form of participating preferred, but will instead try to explain the term and hopefully eliminate some of the FUD around it (we’ll cover the cons/pros in a "mega-post" on term sheets due out soon sometime).
Participating Preferred can be included as part of the structure (terms) of a Series of Preferred Stock. The objective of this term is to provide that Series of Preferred a better return in