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What is a liquidity event?
A liquidity event is the process of converting an illiquid asset into cash.
In the vernacular, it is often used as a synonym for liquidation when applied to bankruptcy or to the forced sale of assets. However, in the startup context (and in finance more broadly), it refers specifically to the process of converting one's ownership stake in a startup, which is not readily convertible into cash, into actual cash.
What are some of the common types of liquidity events?
As a founder, there are several ways to achieve a liquidity event:
- Acquisition: This is when your company gets bought by another company. In this case, you'd receive shares in the acquiring company (this is called a 'stock deal'). Or you could receive payment in cash or bonds (this is called a 'cash sale'). The key thing to do here is to negotiate a good exit package.
- Merger: A merger happens when two companies join together to create one giant mega-company. As part of the process, each company's shares will be swapped for stock from the new combined entity. This makes it easy for shareholders like you to get paid out quickly. Commonly referred to as an 'all stock deal.'
- IPO (Initial Public Offering): An IPO happens when your company goes public and lists itself on an exchange (like on the BSE or NSE). Once your company has gone public, all shareholders can sell their shares on these exchanges if they want liquidity right away.
Reasons for Liquidity Event
A business can have a liquidity event for a variety of reasons, including as a way to:
- Cash out investors who want to realize their returns.
- Cash out founders who want to capitalize on the sale.
- Reward employees with stock options that may be worth more after the liquidity event than if the sale had not happened.
- Go public and raise capital through the sales of shares and bonds in order to expand its business operations and/or enter new markets.
Example of a liquidity event
A liquidity event is the term that refers to getting paid with money from actual sales instead of stock options or ownership of the company through shares.
There are two major ways this can happen: an initial public offering (IPO) and an acquisition by another company.
An IPO happens when a company sells its shares on a public exchange such as the NASDAQ, and you get paid in cash—not stock options—when you sell those shares to the public. The example can be Google's 2004 IPO, but there have been many more since then including Facebook's 2012 IPO, which raised $16 billion dollars at more than a $100 billion valuation.
An acquisition is when one company buys another from another entity such as founders, shareholders, or other investors in exchange for payment through cash, stock, or some combination of the two. For example, Facebook acquired Instagram for $1 billion worth of stock in 2012 before even making any money itself through advertising revenue.