What is a Liquidity Event?

A liquidity event allows shareholders of a company to convert their ownership into either liquid assets, cash, or shares in a company. It's an event where a private company becomes publicly owned or acquired.

The main objective of a liquidity event is to provide investors and shareholders with an opportunity to sell their ownership stake for cash to achieve gains.

During a liquidity event:

1. Current shareholders, employees, and investors have the option to sell their shares and choose between receiving cash or stock from the acquiring company for liquidity.
2. The company raises capital by issuing and selling shares to the public. This infusion of funds can support growth.
3. If it goes public, the company's value is determined based on market pricing and demand for its shares.
4.  After going public, the company's visibility, credibility, and brand recognition generally increase by many folds

In summary, a liquidity event signifies an asset sale or marks the end of private ownership. The event provides shareholders with liquidity by handing over the company's ownership to public markets or via new ownership through an acquisition.

Types of Liquidity Events

Various types of liquidity events occur that enable private company shareholders to convert their equity stakes into cash and become part of the ownership.

Initial Public Offerings (IPOs)

An initial public offering (IPO) is a way for a private company to become publicly traded by selling shares to the public on a stock exchange. Investment banks are involved in overseeing the IPO process, including setting the share price. After the IPO is completed, the company's shares become available for trading on the exchange.

Acquisitions

Acquisitions occur when one company purchases a controlling stake in another. Founders, investors, and shareholders of the acquired firm typically receive compensation in cash or stock from the acquiring entity in exchange for their shares. This enables the acquiring company to gain control over the target company's assets, products, technology, or business operations. Acquisitions are often driven by eliminating competition, expanding into new markets or regions, acquiring talent and technology, or boosting revenue and market share.

Private companies often turn to acquisitions to expand their operations with resources and expertise. These acquisitions also provide a way for shareholders to exit without the need to go public. Typically, the sale price of acquisitions reflects a premium over the market value of the initial investment in the company.

SPAC Mergers

One popular method of achieving liquidity in recent years has been through mergers with a Special Purpose Acquisition Company (SPAC). A SPAC merger occurs when a private company combines forces with a SPAC to transition into becoming traded. The SPAC essentially serves as a company that raises capital through an initial public offering (IPO) specifically for acquiring private companies. By merging with the SPAC, private companies bypass the IPO process making it faster, easier, and more cost-effective. In this transaction shareholders of the company receive stock in the merged public entity.

Direct Listings

On the other hand, direct listings involve listing a company's shares on a public stock exchange without first going through an IPO process. No new shares are issued during this direct listing; only existing shareholders can sell them. This approach reduces compliance requirements while providing insiders liquidity through stock options.

Direct listings are known for their speed and cost-effectiveness compared to IPOs. However, they do not raise capital for the company's early investors. The stock price in listings is determined through an auction process on its first trading day.

Taking Your Company Public - A Look at IPOs

Understanding the IPO Process.

•  Collaborate with investment banks to underwrite the offering and determine the initial pricing of shares.
•  File all paperwork with bodies such as the SEC.
•  Conduct a "roadshow" to promote the IPO among potential investors.
•  Obtain approval for share pricing and allocation on the eve of going public.
•  The day shares are available for trading by the public.

Advantages of an IPO

• Generating an amount of capital to support growth and operations
• Establishing a market valuation by determining the share price
• Increasing brand visibility and credibility 
• Expanding the shareholder base beyond founders and venture capitalist investors
• Providing liquidity for investors and employees

Disadvantages of an IPO

• Incurring high expenses due to the costly process and underwriter fees
• Requiring extensive legal and accounting preparations
• Being subject to ongoing reporting obligations as a publicly traded company 
• Facing the risk of underperformance in share prices during the initial offering
• Experiencing loss of control and increased pressure to meet quarterly performance expectations

Acquisitions

Process

Acquiring another company typically starts with the buyer identifying a target, conducting research, and making an offer. If the target accepts the tender offer, both companies engage in negotiations and create agreements. These agreements outline valuation, terms, timing, required approvals, and other relevant details. Once everything is finalized the deal is closed and the acquired company becomes a part of the acquiring company.

Pros

• Expanding market share generates revenue and gains new capabilities.
• Allows for entry into markets or business areas.
• Enables leveraging the target company's products, technology, and distribution channels.
• Eliminates competition by absorbing rivals.
• Provides access to talent and experienced teams.

Cons

• Involves costs and risks.
• Often requires an integration process.
• This may result in clashes of culture.
• Often necessitates obtaining approvals.
• This can lead to loss of brand identity for the acquired company.

Businesses can grow by merging with or acquiring companies so that they can gain access to employees, advanced technology, and additional revenue streams.  Nevertheless, large transactions pose difficulties like blending values and handling expenses. With careful planning and thorough research, acquisitions can present opportunities for transformative growth.

SPAC Mergers

Process

• When the target company is found, discussions ensue between its shareholders and the SPAC to finalize the terms of the merger.
•  If an agreement is reached, the merging companies combine forces. Within a month, the once-private company becomes publicly traded under the umbrella of the SPAC.

Pros

• Quicker timeline compared to IPOs when it comes to becoming a company.
• Potential cost savings compared to an IPO.
• Scrutiny in what accompanies an IPO process.
• Allows management of private companies to negotiate deals instead of embarking on an IPO "roadshow."

Cons

• There needs to be more certainty in determining the value compared to an IPO.
• Possibility of dilution for existing shareholders due to the involvement of SPAC shareholders.
• The merger process becomes more complex with the inclusion of a SPAC.
• Risk to reputation if opting for a SPAC deal over an IPO

Examples of SPAC Mergers

Private companies like DraftKings, Virgin Galactic, and Lucid Motors have chosen to merge with SPACs, allowing them to transition into traded entities more quickly than if they had pursued traditional IPOs. While risks are associated with SPAC deals, they can be an option for liquidity given the right circumstances and market conditions.

Direct Listings

Process

• The company submits the paperwork to the SEC which includes registration forms and financial reports containing information about its activities, leadership, and finances.
• The company partners with established exchanges like the NYSE or Nasdaq to get its stocks listed. These exchanges carefully review the company's operations to ensure it meets the listing requirements.
• On the trading day, the exchange facilitates trading existing shares, allowing for market-driven price determination. The company does not establish a fixed offering price for its shares.
•  Employees, insiders, and investors can immediately sell their shares on the exchange platform without restrictions during a lockup period.

Pros

• Saves on IPO fees since no underwriters are involved. This makes it a cheaper option.
• No dilution of share value or control since no new shares are created. The founders/investors maintain their stakes.
• Shareholders can sell right away rather than waiting through a lockup period. This provides faster liquidity.

Cons

• No new capital is raised to fund the company's growth.
• Share prices can be more volatile without underwriters to stabilize the offering price.
• Less publicity and marketing than a traditional IPO roadshow. This can limit investor awareness.

Secondary Market Transactions

Secondary market transactions allow investors and employees to sell their shares in held companies to other investors without those companies going public or being acquired. These secondary offering transactions occur between shareholders within the market rather than on public exchanges.

Process

Typically, secondary sales are organized by the company and require approval from its board of directors. They involve documentation to transfer ownership of a significant amount of shares in a private equity firm from one existing shareholder to a new investor. Platforms like SharesPost and EquityZen facilitate these private share transactions through marketplaces.

The company itself issues no new shares of common stock during transactions. Instead, existing shareholders seize an opportunity for liquidity by selling only outstanding shares or a portion of their shares. At the same time, prospective investors can buy into promising companies they believe will have growth potential.

Pros

• Offers liquidity options for employees and investors without going through a liquidity event.
• Allows early shareholders to sell some of their holdings and realize gains.
• Enables the company to maintain control and privacy during an exit process.
• Brings in investors or board members who can contribute expertise and support.

Cons

• It may not maximize returns compared to an IPO or acquisition deal.
• This can lead to challenges related to valuation and discrepancies in information to the parties involved.
• Requires documentation and approval from investors.
• Demands company resources for organizing and facilitating the transaction.

An example of a secondary market transaction

Reddit employees sold their stocks in 2014 as private trades involving SpaceX shares on Nasdaq's SecondMarket before its public listing. These secondary sales offered investors opportunities to access growth companies before they went public. 

Preparing for a Liquidity Event

A successful liquidity event requires planning and preparation. Companies should develop a strategy for the startup liquidity event starting 12 to 24 months before the anticipated date. Here are some essential steps in the preparation process.

Allocate significant time to conducting audits, filing documents, preparing financial statements, marketing materials, and other related tasks.

Ensure the management team carefully allocates time for informed decisions, evaluates all choices, and establishes transparent expectations at every stage.

Advantages of Liquidity Events

Liquidity Event. A liquidity event pertains to transactions like IPOs or acquisitions that shift a company's ownership from private to public. This enables investors and shareholders of a company to sell their ownership shares giving them access to cash and a chance to exit. It's worth mentioning that not all shareholders are required to sell their shares in the event of liquidity.  The company continues its operations as an entity.

Exit. On the other hand, an exit occurs when a company's founders, early investors, and shareholders completely sell off their ownership positions in a company's most liquid asset. They divest themselves of all equity stakes and sever ties with the company altogether. Unlike a liquidity event which offers the choice of exiting rather than being forced, an exit definitively marks the end of their ownership involvement.

Partial vs. Full Exit. Sometimes, a liquidity event occurs as an exit for investors who opt not to sell all of their shares. Conversely, an exit represents a termination of ownership where all shares are sold. While liquidity events present the opportunity for an exit, they do not guarantee that all will choose this path.

Company Status. Following a liquidity event, the company can still function as a traded entity. However, all ownership positions are in the case of an exit or liquid asset. The company might continue independently or be integrated into a parent entity.

The crucial difference between common liquidity events is that a liquidity event allows for the possibility of an exit by making shares tradable. It doesn't entail a termination of ownership as an actual exit does; rather, it paves the way for an exit.

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