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Liquidity Event: The Key to Planning Your Exit Strategy

An exit plan is helpful for the company owner, employees, and investors.

When evaluating whether or not to put money into a firm, potential investors value exit strategies.

The success of the company is the goal of all entrepreneurs. They invested time, resources, and effort. They anticipate potential problems and prepare for them in advance. A vital component of such preparations should be an exit strategy.

This article will help you understand the liquidity event in detail and build a better exit strategy for your business.

Liquidity Event: Exit Strategy Planning

To get the most possible value from any exit strategy, careful planning and implementation are required.

59% of private company decision-makers report feeling increased pressure to hold a liquidity event. - Source: Morgan Stanley

To understand liquidity event examples and exit strategies better, you must know how they work. The following section will give you a comprehensive idea of the concepts.

Liquidity Event

What is a Liquidity Event?

A liquidity event is when a business is bought, merged, goes public for the first time, or does something else that lets its leaders and early investors sell some or all of their shares.

Liquidity events are ways to get out of illiquid investments, such as shares of stock that don't move much or at all. Investors (including VC companies, angel investors, and private equity firms) anticipate a liquidity event to occur within a reasonable length of time after originally committing their cash, and the founders of the company naturally strive toward this outcome.

IPOs and direct purchases by other corporations or private equity groups are the most typical forms of liquidity occurrences.

Types of Liquidity Events

When liquidity events take place, shareholders have the opportunity to cash out some or all of their interests in the company. A founder may experience a liquidity event in several ways:

  • Acquisitions - When a corporation buys out another, it is called an acquisition. As part of the transaction (known as a "stock deal"), you would get an ownership stake in the acquiring firm. Payment in the form of cash or bonds (a "cash sale") is another option. Negotiating a favorable separation agreement is a top priority.

  • Mergers - A merger occurs when two or more firms combine into one much larger business. Shares from both companies will be exchanged for equivalent numbers of shares in the merged firm. This facilitates the speedy distribution of dividends to shareholders. This kind of transaction is sometimes called an "all-stock deal".

  • IPOs - When a firm first begins trading publicly, it is said to have an IPO (Initial Public Offering). All shareholders will have access to these markets after your firm has gone public if they need immediate liquidity.

How Does a Liquidity Event Work?

When founders or VC firms sell off their first interests in a company, this is called a liquidity event. The initial few workers of these firms also stand to gain financially from their company becoming public or being acquired by another business.

When a company is acquired, its founders and staff are often kept on. As they complete their obligations to the new owners, they will get extra remuneration in the form of shares or cash.

Nearly 50,000 mergers and acquisition (M&A) deals were completed worldwide in 2022. - Source: Statista

It's important to realize that investors aren't always looking for a liquidity event, even if the company's founders are. The financial rewards of a liquidity event may not be enough to incentivize founders. When approached by early investors, several startup founders have avoided going public out of concern for the company's future.

Liquidity Event Example

A liquidity event refers to receiving payment in the form of cash from genuine sales rather than stock options or company ownership.

The two most common ways this occurs are via an IPO and a merger or acquisition.

An initial public offering (IPO) is the sale of a company's shares to the general public via a publicly traded market like the NASDAQ; in this case, you get paid in cash rather than stock options.

There have been several successful initial public offerings (IPOs). Example Google IPO in 2004; another notable example is Facebook IPO in 2012.

A total of 6,040 initial public offerings (IPOs) have taken place between 2000 and 2023. - Source: Stock Analysis

Why is a Liquidity Event important for your Exit Strategy?

An investor's exit strategy may include a liquidity event if it will result in the investor receiving cash or shares in exchange for an illiquid investment. Early-stage financing by VC and PE companies in a business is usually done with the hope of making a profit at a later liquidity event.

They hope that this liquidity event could happen soon and provide them with a massive return on their money—possibly even an exponential one.

However, investors aren't the only parties that may benefit from a liquidity event. Founders and workers with various forms of stock pay stand to gain as well, though not all founders see a liquidity event exactly as a main driving driver.

The type of liquidity event a company pursues is influenced by factors such as valuation, fundraising, cash flow, and overall business goals.

Tips to effectively plan your Liquidity Event

Because the danger of insufficient liquidity is such an important consideration, investors should formulate a plan for how to best place their businesses in a position to profit from a liquidity occurrence.

The following are some suggestions that might help you get ready for one.

Find the Right Buyer

It might take anything from a matter of days to many years to find a buyer. It might be difficult if your company has poor financial results or is in an industry with little competition.

Your purchaser may be a rival company, an investment firm, a hedge fund, or even a collaborator in your ecosystem. Your best bet may be to work with private equity and hedge funds that specialize in your industry. To keep them interested in your product or service, you must become an expert communicator.

Audit Your Finances

Organizing your company's finances is essential if you plan on winding down operations. It's useful for avoiding potential difficulties along the route that could otherwise be missed.

Even if you trust the numbers coming out of your finance department, an impartial outside auditor should be brought in to ensure accuracy.

The effects of liquidation are typically disastrous when business owners depend only on internal audits. Business bias, coverups, and a lack of independence may undermine the credibility of internal evaluation processes. Third-party audits are worth considering if you value absolute certainty.

Companies of different valuations consider different metrics when planning liquidity events. Higher-valued companies focus on valuation and/or revenue and cash flow, while lower-valued companies are more influenced by funding stage, overall market, and economy. - Source: Morgan Stanley

Create a Solid Team

It's easy for liquidation to become a stressful and time-consuming process. It may develop in ways that are beyond your management or knowledge. The stress of thinking strategically and organizing several projects may be reduced by assembling a group of advisers. Your long-term investment and equity are on the line, and you need the help of industry experts.

Liquidation specialists, financial managers, and lawyers should all be part of your professional team. An inclusive team working together may have a big influence on the final result of the liquidation process. A professional attorney will guide you through the legal requirements of running a company and may even double as a curator.

Wrapping Up

Accurate liquidation requires knowing both the absolute and relative worth of your company. The asset sharing and current ratio figures are the primary negotiating points. The correct value of your firm may also be determined by using other metrics, such as the price-to-sales, price-to-growth, and price-to-earnings ratios. Your company's valuation is a function of more than just its market value. But if you use the appropriate methods, you should be able to get closer to the mark.

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