From IPOs to M&A: Navigating the Different Types of Liquidity Events
Building a startup is a journey. Over the course of your journey, chances are the thought of liquidity events will creep into your mind. Understanding liquidity events and having a game plan when your startup is close to an event can help speed up the process.
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To learn more about liquidity events and how to prepare your startup for one, check out our post below:
What is a liquidity event?
As put by the team at Corporate Finance Institute, “A liquidity event is a process by which an investor liquidates their investment position in a private company and exchanges it for cash. The main purpose of a liquidity event is the transfer of an illiquid asset (an investment in a private company) into the most liquid asset – cash.”
Depending on the type of event and makeup of your business will dictate the small details of your liquidity event. Learn more about specific types of liquidity events below:
Types of liquidity events
Liquidity events can come in different shapes and sizes. Understanding the different outcomes will help you game plan and prepare your business for the proper event.
Going public
An initial public offering (IPO) or going public is the typically startup ending in Hollywood. As put by the SEC, “Going public typically refers to when a company undertakes its initial public offering, or IPO, by selling shares of stock to the public, usually to raise additional capital. Going public is a significant step for any company and you should consider the reasons companies decide to go public. After its IPO, the company will be subject to public reporting requirements.”
Getting acquired
Getting acquired is also a potential liquidity event for startups. For many founders, this is typically the most thought-through process.
As put by the team at Investopedia, “An acquisition is when one company purchases most or all of another company’s shares to gain control of that company. Purchasing more than 50% of a target firm’s stock and other assets allows the acquirer to make decisions about the newly acquired assets without the approval of the company’s other shareholders.”
As an acquisition is ultimately selling your business, you need to understand the motivators for companies making acquisitions. For example, companies might be motivated by a few of the following reasons:
- Enter New Markets — Companies making acquisitions might be interesting in operating in a new geographic or vertical market.
- Growth — Companies making acquisitions might want to use your product or service as a growth strategy for their current business.
- New Technology — Companies making acquisitions might want to lean into your technology instead of building it in-house.
- Remove Competition — Companies making acquisitions might want to reduce their competition.
Secondary market transactions
As put by Investopedia, “The secondary market is where investors buy and sell securities they already own. It is what most people typically think of as the “stock market,” though stocks are also sold on the primary market when they are first issued.” Over the past few years, secondary markets specific to startups and private help companies have begun to find their way into the marketplace.
Realistic timeline for liquidity events
Putting a timeline on a liquidity event is difficult and will greatly vary from business to business. Depending on your business, the type of liquidity event, and current market conditions will impact the timeline.
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First things first, you need to have a product or service that is attractive to the public markets, a company, or a secondary market. The next steps will greatly vary depending on the market and the liquidity event type. For example, going public can take years with the legal requirements and work. On the flip side, an acquisition can move quickly if the company is motivated and dedicated to moving quickly.
Learn more about preparing for a liquidity event below:
Tips for startups close to a liquidity event
If a liquidity event is on the horizon, check out a few of our tips to prepare below:
1. Look at the liquidation preferences
As put by the team at Investopedia, “A liquidation preference is a clause in a contract that dictates the payout order in case of a corporate liquidation. Typically, the company’s investors or preferred stockholders get their money back first, ahead of other kinds of stockholders or debtholders, in the event that the company must be liquidated.”
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Checking out the contract to understand the liquidation preferences is a must to make sure you can properly communicate this with your board members and stakeholders.
2. Understand and look for a clawback clause
As put by the team at Paycor, “A clawback clause is a provision within a business or employment contract that allows—under a prescribed set of circumstances—an organization to reclaim incentive or bonus funds previously paid to an employee.”
This is particularly important when looking at different bonus and payout structures. For example, if you had a goal to grow 10% over the next year and initially reported 13%, you’d get your payout. However, after an audit you found the actual growth rate to be 9%, you may have to pay back your bonus.
3. Consider tax implications
Each liquidity event will come with its own set of tax implications and legal requirements. As always, we recommend consulting with a lawyer and financial team when evaluating your different tax implications.
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4. Know the pros and cons of each liquidity event
Of course, each liquidity event comes with its own set of pros and cons. Check out a few examples below:
Going public
Pros:
- Raising capital
- Exposure from the public listing
- Allow individuals to exit
Cons:
- Added disclosure for public investors
- Increased rules and regulations
Getting acquired
Pros:
- Access to capital
- Additional resources
- Allows individuals to exit
Cons:
- Operational confusion
- Impact on current team members
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Building relationships with your current and potential investors will allow you to move quickly when it comes time for a liquidity event. Keeping your investors in the loop will allow them to lend a hand when it comes to strategy, introductions, and more.
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