I'm describing non-participating preferred, which as you point out is far more common.
Here's how it would go with participating preferred. As before, I invest $10 million at a $90 million pre-money valuation. If the firm sells for $200 million, first I get back my $10 million. Then I convert to common and get 10% of the remaining $190 million, or $19 million. Before I got $20 million (10% of $200 million). Now I get $29 million. (In the down round scenario, the outcome is the same.) Participating preferred is--nowadays--increasingly confined to distressed finance.
TL; DR Participating preferred gets to have its cake and eat it too. Non-participating preferred must choose between (a) its preference or (b) converting to common.
I'm describing non-participating preferred, which as you point out is far more common.
Here's how it would go with participating preferred. As before, I invest $10 million at a $90 million pre-money valuation. If the firm sells for $200 million, first I get back my $10 million. Then I convert to common and get 10% of the remaining $190 million, or $19 million. Before I got $20 million (10% of $200 million). Now I get $29 million. (In the down round scenario, the outcome is the same.) Participating preferred is--nowadays--increasingly confined to distressed finance.
TL; DR Participating preferred gets to have its cake and eat it too. Non-participating preferred must choose between (a) its preference or (b) converting to common.