What is a liquidity event?

A liquidity event is a significant moment involving the conversion of shareholders’ ownership in a company into cash or other assets. Such events can take various forms, including an initial public offering (IPO), acquisition, merger, buyouts or secondary offerings. 

Understanding liquidity events is essential for startup founders, investors, and anyone interested in the financial health of a business. In this page, we will explore what a liquidity event is, how it works, and why it matters.

Liquidity event legal definition

The legal definition of a liquidity event is an event in which a company's shares are sold or transferred, resulting in a significant change in the company's ownership structure and an increase in available funds or liquidity.

In simpler terms, a liquidity event is a way for a company to turn its assets into cash by selling part or all of the company's ownership to investors, such as through acquisition, IPO, or merger.  These events can be significant turning points for a company as they can provide much-needed funding to grow, pay off debt, or even reward early investors or employees with financial gains.

From a legal standpoint, liquidity events involve the transfer of ownership and assets, requiring careful planning and execution to ensure compliance with regulations and laws. 

However, from a business perspective, they offer a chance for companies to take a big leap forward and achieve their goals by accessing new funding sources, expanding their customer base, or even acquiring new technology or talent.

Forms of Liquidity events

As mentioned above, a liquidity event could come in different shapes and forms. Below are some of the most common forms of liquidity events.

Initial Public Offering (IPO)

An IPO, or initial public offering, is when a private company offers its stock shares to the public for the first time. This allows the public to invest in the company and provides the company with access to new sources of capital for growth and expansion.

Acquisition

An acquisition occurs when one company purchases another company. This allows the acquiring company to gain control of the acquired company's assets, intellectual property, and customer base. Acquisitions can also provide opportunities for cost savings, increased market share, and access to new technologies or talent.

Merger

A merger is a corporate strategy in which two companies combine to form a new entity. The goal is to create a stronger, more competitive business that can benefit from synergies, such as cost savings or increased market power. 

In a merger, the shareholders of both companies typically receive shares in the new entity in exchange for their old shares. A merger can be a way for companies to achieve economies of scale, diversify their business, or enter new markets.

Buyout

When a company or investor groups purchase a controlling stake in a company, it’s called a buyout. In this situation, the acquiring party gains control of the company's assets. Typically, the purchased company becomes a private company, and its shares are delisted from public exchanges.

A buyout can provide a liquidity event for the selling shareholders, as well as opportunities to cut costs and improve the acquiring company’s operations.

Secondary offering

A secondary offering occurs when a company issues new shares of stock to the public after its initial public offering. This provides a liquidity event for the company's early investors, who can sell their shares in the secondary offering. It also generates additional funds for the company.

What is a startup liquidity event?

A startup liquidity event refers to any event that allows a startup to convert its equity or ownership stake into cash or another asset, resulting in a significant change in the startup’s ownership structure. This event often occurs when a startup reaches a certain growth stage, such as an initial public offering (IPO), acquisition, or merger.

Benefits of liquidity events for startup companies

As a startup leader, a liquidity event can help your startup in several ways. Let’s look at some of the most significant ones.

• Access to significant funding: A startup liquidity event can provide access to a large amount of cash or funding that you can use for growth and expansion.
• Rewarding early investors and employees: By selling their equity stake, early investors and employees can realize a significant financial gain. This incentivizes them to continue to support the startup.
• Increased visibility and profile: An IPO or acquisition can generate significant media attention and increase brand awareness among potential customers, partners, and investors.
• Exit strategy: A startup liquidity event can provide an exit strategy for you as a founder and other early investors who may be looking to exit the business or cash out their investments.
• Increased credibility: A successful liquidity event can increase your startup credibility, making it more attractive to potential customers, partners, and investors.
• Diversification of shareholder base: A liquidity event can result in a more diverse shareholder base, which can help mitigate risks and provide access to a wider range of resources and expertise.
• Increased access to resources: A liquidity event can provide access to new resources, such as technology, talent, and expertise, which can help fuel growth and expansion.
• Alignment of incentives: A startup liquidity event can help align stakeholders' incentives, ensuring that everyone is working towards the same goals and objectives.
• Valuation: A successful liquidity event can increase the company's valuation, making it more attractive to potential investors and partners.
• Increased control: A liquidity event can give the management team increased control over the company, allowing them to make strategic decisions and investments.

Liquidity event: Key takeaways

A liquidity event provides a significant opportunity for both startups and their investors. By familiarizing yourself with the different types of liquidity events, such as IPOs, acquisitions, and buyouts, you can make informed decisions about your company's future and the best strategies for realizing your returns.

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Disclaimer: LTSE is neither a law firm nor provides legal advice. Before making decisions on matters covered by this post, readers should consult their legal adviser.