What Is a Liquidity Event?
The day in 2012 when Facebook became a publicly traded company was a good day for founder Mark Zuckerberg and the company’s early investors. Facebook’s $16 billion initial public offering (IPO) at a company valuation topping $102 billion made Zuckerberg a multi-billionaire overnight. The VC firms Accel Partners and Breyer Capital also netted a remarkable return, turning the millions they invested in Facebook’s Series A round into billions. It was among the biggest IPOs in tech history—and a great example of how a liquidity event can create massive wealth for founders, investors, and employees alike.
An IPO is one common type of liquidity event, but it’s not the only kind. Just two years after going public, Facebook was involved in a different liquidity event—an acquisition—when it bought the messenger service WhatsApp for $21.8 billion.
If those figures are starting to make your head spin, we don’t blame you. Let’s take a breath and review the basics of liquidity events and what you should know about them as a founder and investor.
- What is a liquidity event?
- What are the different types of liquidity events?
- When do liquidity events usually happen?
- Pulley scales with startups from early-stage to IPO
What is a liquidity event?
A liquidity event is a means by which a company’s founders and early investors turn their illiquid assets into liquid assets. Assets are considered “illiquid” when there’s no easy or obvious way to exchange them for “liquid” assets, such as cash or something that can easily be sold for cash (e.g. shares in a public company).
A liquidity event is typically part of an investor’s exit strategy, as it allows them to convert their illiquid investment into a liquid return of cash or shares. Venture capital and private equity firms that invest in startups in early funding rounds almost always do so with the expectation that they will net a profit in a liquidity event. In their ideal scenario, this liquidity event will take place in the not-too-distant future and will result in an outsized, even exponential, return on their investment.
But investors aren’t the only stakeholders who may stand to profit in a liquidity event. Founders and employees holding other types of equity compensation also stand to benefit, though not every founder sees a liquidity event as a primary motivating factor. Though a company’s co-founders and early investors generally work together to plan a liquidity event such as an IPO or an acquisition, their timelines and goals don’t always align.
What are the different types of liquidity events?
As we mentioned above, liquidity events can come in a few different flavors and can happen at different phases in a startup’s journey. Let’s take a look at some of the most common types of liquidity events and what triggers them.
Initial public offering (IPO)
Many entrepreneurs and business owners dream of taking a startup all the way from its early days to an IPO. This is historically the most common way for a company to issue and offer new shares to the public on a public stock exchange.
An IPO signifies an impressive milestone and an opportunity for a company to raise a significant amount of new capital from public investors. More importantly for existing investors, it also signifies a liquidity event that will allow them to finally own and monetize liquid assets in the company.
With that being said, existing investors and company insiders may need to wait for a certain period of time after an IPO before they can sell their shares. This is known as a “lock-up period.” Under the SEC’s Rule 144, a lock-up must last at least 90 days following the receipt of shares but can last for up to several years depending on the specific agreement.
Other ways of going public
An IPO is the most common way for a company to go public, and it’s certainly the way most founders and employees are passingly familiar with. But there are other ways to go public, too.
A company might, for example, go public via a direct listing in which no new shares of the company are created and only outstanding shares are listed on the stock exchange. Unlike an IPO, this method requires no underwriters and avoids some other features of a typical IPO, such as the lock-up agreement. One example of a company that went public through a direct listing is Spotify, which did so on the New York Stock Exchange (NYSE) in April 2018.
A company may also opt to go public via a Special Purpose Acquisition Vehicle, or SPAC. In this case, the company merges with a SPAC that’s already publicly listed. SPACs have become more popular in recent years, with private companies such as BuzzFeed and SoFi opting to go public via SPAC.
Another common type of liquidity event is a direct acquisition, in which one company or firm is sold to another for an agreed-upon price. The example we cited above, in which Facebook bought WhatsApp for $21.8 billion in 2014, is an example of such an acquisition.
While these liquidity events may not make the news unless they’re bigger acquisitions involving well-known companies, they are a major part of a VC firm’s calculus. Founders and employees can also receive cash or shares of the purchasing company in an acquisition, and in many cases they are retained to work for the new company or firm as well.
A secondary market transaction such as a tender offer can also qualify as a liquidity event, as it allows certain investors to sell all or part of their stake in a startup. A tender offer is essentially a company-sponsored liquidity event in which some investors are given the opportunity to sell their shares to other investors—or even back to the company itself.
There are several different reasons why a company might engage in a tender offer, not least of which is to throw a bone at early investors and employees who haven’t seen a liquidity event for years. By giving these folks a liquidity event in which they can “cash out” in the short term, the company may be able to buy more patience and/or good will before an IPO or acquisition.
An example of this occurred in 2018, when Credit Karma received a $500 million secondary investment from Silver Lake and subsequently arranged a tender offer for employees and other existing shareholders. (Two years later, in 2020, Credit Karma was acquired by Intuit in a different type of liquidity event.)
When do liquidity events usually happen?
The short answer is, it depends. Investors may have to wait a long while for a liquidity event to occur, due to factors that may or may not be within the startup’s control.
Certain market conditions, such as an economic downturn, can lead companies to delay or pause plans to go public. These conditions may vary from industry to industry, but they aren’t always easy for founders and investors to predict.
Of course, there are also internal factors that can delay a liquidity event. Some founders or co-founders may not agree with investors on the timeline for a liquidity event. They may even be reluctant to take a company public at all if it means a loss of personal control. This is one reason why it’s important for both founders and investors to have a conversation about exit strategy upfront, to ensure that everyone’s on more or less the same page.
In general, VC firms and other investors do expect a liquidity event to occur within a reasonable period of time. “Reasonable” can mean different things to different people, but a good benchmark is roughly 5–7 years after the initial investment. Of course, having a good relationship and clear communication with investors can be important when discussing the possibility of an upcoming liquidity event.
Pulley scales with startups from early-stage to IPO
Speaking of having a good relationship with investors, Pulley’s fundraising modeling can help your startup save thousands on legal fees while giving your investors the transparency they crave.
Our tool creates a complete pro-forma for your next fundraising round, with clear insight into the ownership and numbers of shares for each founder, employee, current investor, and future investor across different fundraising models. And Pulley helps to ensure that you’ll be well-prepared for your next liquidity event months before it arrives, with a waterfall model that helps you model out different liquidity-event scenarios.
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