What Is a Liquidity Event?
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A liquidity event is a transaction that lets a company's investors, founders, or employees turn their ownership stakes into cash or liquid assets. This event often happens through acquisitions or public offerings, which can shift a company from private to public ownership. Mergers, where two companies join together into a single entity by combining assets, operations and management, can also trigger an event. For investors, this can present an opportunity to monetize investments and potentially earn returns.
If your company is going through a liquidity event, a financial advisor can work with you to maximize the value of your assets, manage taxes and plan for financial goals.
What Is a Liquidity Event?
A liquidity event, also known as an exit, lets a company's shareholders gain access to liquid assets by selling or exchanging their shares. Liquidity events often involve swapping shares for cash. Sometimes investors will trade illiquid ownership stakes in a private company for much more liquid shares in a public firm. These shares can then be exchanged for cash.
Providing early investors with a way to cash out their stakes is not the only purpose or outcome of a liquidity event. It can also shift the company’s ownership structure, bring in new capital or provide access to new markets and technologies.
Types of Liquidity Events
Liquidity events can take many forms. Here are five that can have specific implications for the company and its stakeholders:
Initial public offering: An IPO occurs when a private company goes public by offering shares to the general public for the first time on a stock exchange. This can allow the company to raise substantial capital while providing existing shareholders with the opportunity to sell their shares. IPOs can offer high visibility and financial gain, but also involve regulatory scrutiny and increased public reporting requirements.
Acquisition: In an acquisition, another company purchases the business, allowing shareholders to sell their stakes for cash or shares in the acquiring company. Acquisitions can provide immediate liquidity and often occur when a larger company wants to expand its capabilities or market share by integrating a smaller business. This type of liquidity event can bring valuable resources and strategic advantages to the acquired company, but may result in a loss of autonomy. Acquisitions are the most common type of liquidity event. These often occur earlier in a company's history and involve a smaller financial transaction than an IPO.
Merger: A merger is when two companies combine to form a new entity, typically with the shareholders of both businesses receiving shares in the newly formed company. While mergers can provide liquidity to shareholders, they often focus on creating synergy between the companies, which may result in new growth opportunities and an enhanced competitive position. Mergers can be beneficial for achieving economies of scale and leveraging complementary strengths with other operating businesses. Mergers may occur through special purpose acquisition companies (SPACs), which are non-operating public companies set up specifically to merge with private businesses.
Private equity buyout: In a private equity buyout, a private equity firm purchases a majority or complete stake in the company, often with the intention of restructuring and improving it before selling it for a profit. This type of liquidity event can offer a quick payout for shareholders, and it typically occurs when private equity firms identify undervalued companies or businesses with growth potential. Buyouts may lead to significant changes in company operations and strategy.
Secondary sale: In a secondary sale, shareholders, such as employees or early investors, sell their shares to other investors. This provides liquidity without the company undergoing an acquisition, IPO or merger. Secondary sales are common in private companies where there may be no immediate plans for a full liquidity event, but certain stakeholders wish to cash out their shares.
Why Liquidity Events Are Important
Liquidity events allow shareholders to convert their investments into cash, often resulting in financial gains. For early-stage investors and venture capitalists (VCs), liquidity events represent the culmination of years of strategic investment, signaling that their financial support has helped a company grow and succeed. VCs, for example, often plan for liquidity events occurring five to seven years after they invest.
In addition to rewarding investors, liquidity events are significant milestones for the companies involved. These transactions can provide opportunities to raise capital, expand or achieve strategic goals through mergers or acquisitions.
Going public through an IPO, for example, can bring in significant capital to fund research and development, marketing or expansion initiatives. Similarly, an acquisition or merger can allow a company to access new markets, leverage synergies or acquire valuable resources, such as intellectual property or technology. In the case of a private equity buyout, the acquired company can benefit from the expertise and capital infusion provided by the private equity firm.
For individual stakeholders, liquidity events can have life-changing financial implications. Employees and founders with stock options or equity stakes can finally access the cash value of their shares, which can provide the resources needed for other ventures or personal financial goals.
Liquidity events also have complex tax considerations, as the proceeds may be subject to capital gains tax. Proper planning with financial advisors can help stakeholders maximize their gains and minimize tax liabilities.
Frequently Asked Questions
How Does a Liquidity Event Affect Employees With Stock Options?
Employees with stock options may benefit from liquidity events by exercising their options to acquire company shares, which they can then sell during or after the event. The terms and timing depend on the company's stock option plan and the type of liquidity event.
Do Liquidity Events Always Result in Financial Gains?
Not necessarily. While liquidity events often lead to financial gains, especially if the company has grown in value, outcomes vary based on the type of event and the company's performance. In some cases, shareholders might not see a significant return if the company's valuation declines before the event.
Bottom Line
Liquidity events are important for investors and companies that can offer opportunities to realize financial gains and support business growth. For investors, these events could turn equity investments into actual returns. For companies, they can provide capital, strategic partnerships and growth opportunities. Investors should assess exit opportunities and plan for tax impacts during liquidity events.
Investment Planning Tips
A financial advisor can also help you evaluate different exit strategies, reinvest proceeds and align a liquidity event with your overall financial plan. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
SmartAsset's capital gains tax calculator can help you estimate how much you could owe in capital gains tax when you sell an appreciated asset.
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