Liquidity event: Overview, definition, and example
What is a liquidity event?
A liquidity event refers to a situation or transaction that allows a business or individual to convert assets, typically equity or investments, into cash or a more liquid form of financial resources. Liquidity events are often significant milestones for companies and investors because they provide a way to realize the value of an investment. Common examples of liquidity events include the sale of a company, an initial public offering (IPO), or the sale of stock or other assets. These events allow stakeholders, such as investors, employees, or business owners, to access cash or liquid assets from their investments.
For example, when a startup company is acquired by a larger firm, the shareholders of the startup may receive cash or stock in the acquiring company, which represents a liquidity event.
Why is a liquidity event important?
A liquidity event is important because it enables business owners, investors, and stakeholders to access the financial value of their investments. For startups, early investors, and employees who hold equity or stock options, liquidity events provide an opportunity to convert their ownership interest into cash or publicly tradable assets. This event can serve as a reward for taking on the risk of investment or working at a startup. For businesses, liquidity events can provide capital that can be reinvested in new ventures, pay off debts, or support growth initiatives.
For investors, liquidity events are crucial because they represent the realization of an investment's return, allowing them to cash out or diversify their portfolio.
Understanding liquidity event through an example
Imagine an early-stage tech company that has raised venture capital from investors. After several years of growth, the company is acquired by a larger corporation for $50 million. The investors, along with the company’s founders and employees who hold equity, receive a portion of the acquisition price in cash or stock in the acquiring company. This acquisition is a liquidity event because the investors and stakeholders are able to convert their ownership in the private company into cash or publicly traded stock.
In another example, a startup that has been privately held for several years decides to go public through an initial public offering (IPO). The founders and early investors sell some of their shares in the offering, realizing the value of their equity in the form of cash. This IPO is also a liquidity event, as it provides liquidity for the company’s investors and shareholders.
An example of a liquidity event clause
Here’s how a liquidity event clause might look in an investment agreement:
"In the event of a Liquidity Event, such as a sale, merger, or initial public offering, the Investors shall have the right to receive their proportionate share of the proceeds, as defined in this Agreement. The Liquidity Event shall trigger the conversion of all outstanding preferred shares into common shares and the distribution of funds to all eligible shareholders."
Conclusion
A liquidity event is a key milestone for investors, business owners, and employees who hold equity in a company. It allows them to realize the financial value of their investment, either in cash or through publicly traded securities. Whether through an acquisition, IPO, or asset sale, liquidity events provide an opportunity to unlock the value of ownership, reward stakeholders, and provide the necessary financial resources for future endeavors. Understanding liquidity events is important for both companies and investors in planning for growth, exit strategies, and financial outcomes.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.