What is a Liquidity Event?
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.
A liquidity event is a form of the exit strategy utilized by private equity firms. Usually, the event is carefully planned long before it is triggered. It is typically triggered when certain conditions are met or particular circumstances have arisen. The founders of the company and the investors are the primary parties interested in the event.
Forms of Liquidity Event
1. Initial Public Offering (IPO)
The company’s shares become publicly traded after an IPO. The company’s founders and investors may sell their shares and monetize their initial investments.
2. Direct Acquisition
Instead of going public, the company or a stake in the company can be sold directly to an interested party (e.g., private equity firm). This is another method of monetizing an initial investment.
Reasons for a Liquidity Event
A liquidity event can be triggered due to the following reasons:
- Profit target is reached
- Loss prevention
- Legal reasons
- Dramatic change in market conditions
Example of a Liquidity Event
PE Partners is a private equity firm that invested $5 million in NewTech Corp., a technology startup. In its five years of operations, NewTech Corp. has experienced significant growth and become very profitable. In order to raise additional financing for further growth, the company’s management decides to undertake an IPO.
PE Partners assesses the market conditions and the company’s growth potential and concludes that an IPO would be the best way to liquidate their investment. During the IPO, PE Partners sold their stake in NewTech Corp. for $25 million.
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