A liquidity event sounds like it could be a company happy hour. It's not quite that, but a liquidity event is still a reason to celebrate. For companies, liquidity events allow shareholders to sell their stock and cash out. There are a few different kinds of liquidity events and a majority of them require a company to be public.
Companies can offer shares owned by employees for purchase to the general public. To do so, companies must be publicly listed on the stock exchange, and the listing could happen in a few different ways.
Going public the traditional way
The most popular liquidity event is when a company prepares for an initial public offering.
As part of the IPO process, public investors like mutual funds, hedge funds, or pensions are invited to invest in the company. These investors make the first public investment in the company by buying newly minted common shares through what is called a primary offer.
As company employees or consultants, we won't be able to sell our shares to these investors. Instead, we'd be able to sell our shares to other public investors on the secondary market pending certain restrictions like lockup periods and blackout periods.
Typically after an IPO, lockup periods cover the first 6 months. The lockup period is negotiated and determined between the company and investment banks underwriting the public offering. Companies are encouraged to use lockups to prevent mass selling and to stabilize the price of the stock during the early months of trading.
Lockups are typically a one-time affair, while blackout periods happen quarterly. These periods are set in place to prevent employees from selling based on insider or private information that hasn’t been disclosed to the public.
Merger and acquisition
Another traditional way to go public is through a merger or acquisition with a public company.
During an acquisition, the target startup works with the public acquiring company to fold the product and team into the acquiring company. It's quite often that acquisitions result in lower valuations assigned to the target company compared to IPOs.
New ways to go public
Companies are starting to consider going public via direct listings instead of hiring bankers.
Progressive companies like Coinbase, Slack, and Spotify have been changing the traditional IPO model by going public with a direct listing. The company does not issue any new shares in a direct listing. Instead, the company sells existing shares held by founders, employees, and venture capitalists. With the direct listing route, employees and insiders are not subject to a lockup period and can sell right away.
There is also a subset of companies pushing the envelope further by going public through a SPAC.
SPACs are currently dubbed IPO 2.0 by the venture community, and it is another way for startups to go public in place of a traditional IPO.
Through a SPAC merger, the startup is absorbed or merged into a pre-existing public company, the SPAC. SPACs themselves build no product or serve any customers. Instead, they are blank shell companies created by a promoter for the sole purpose of raising money to acquire private companies. After a target is identified and the board approves, the private company is absorbed by the shell company and we have a new publicly-traded company.
Liquidity events can be fairly predictable. While the startup is growing, the early liquidity events available are tender offers or secondary transactions. These usually occur around the same time as a round of financing is announced. After a few rounds of financing, mergers and acquisitions come into play before the company becomes too expensive to buy. This can come in the form of a traditional acquisition or even a SPAC. In the case the company has raised many rounds of financing such as Series E, F, G, an IPO or direct listing would be the preferred method to achieve liquidity. Knowing the current stage of the company will help you prepare for the next possible liquidity event.
For extra insight, check out the video by expert Mike Zung, CFP® over on the Watch tab!
Learn more about SPACs with an Archimedes blog post.
Learn more about direct listings.