liquidity event or exit
A liquidity event or exit refers to a time when equity holders in private businesses are able to sell their equity. Because these events are rare and often represent a time where enterpreneurs and investors can "harvest" the results of years of effort, they are generally very positive events.
New business ventures are typically highly illiquid. This means that there is no easy way to sell the company's equity. Willing buyers may exist but they are hard to find and require significant education about the company before they are willing to buy. Simply assessing the prospects of a private company takes time. In the US, the Securities and Exchange Commission regulates buying and selling activity of privately traded companies further complicating process.
Most of the time liquidity events arise when a new venture becomes so successful that another company wants to buy it or it has the ability to become a public company (where many retail investors buy a large portion of the company). In case of a merger or acquisition, sometimes stock in the seling company is bought for cash, sometimes for stock in the acquiring entity, and sometimes in a combination of both.
There are 4 common forms of liquidity events:
- IPO--This is where shares in a private company are sold to the public via a process known as an Iniital Public Offering. Once shares are listed on a public stock exchange, it becomes easy to buy and sell them.
- Merger or Acquisition--This is where a large or complete stake in a private company is acquired or merged into another company either public or private.
- Buy-out--This is where another firm or the management team buys out a group of shareholders.
- Investor sale--This is where an investor in the company agrees to provide cash to buy out one or more shareholders. Sometimes investors will do this to boost their ownership percentage.
Liquidity events can result in the sale of all or only a portion of the equity in a private company. However, liquidity itself, the increased ability to buy and sell equity in a private company, is always a positive.
Investor Purchase of Private Equity
Specialized buyers of new venture equity exist. These are called Venture Capitalists. Venture Capitalists make money by buying equity in small private companies and new ventures at low prices with hopes that they will be able to sell the equity for much more money as the company grows or scales. They generally do not like to "buy out" existing investors (giving them cash for equity) rather they prefer for the company to create new stock for them to buy. In effect, they are buying stock from the company not from individual investors. This is because 1) they prefer to keep the existing stockholders (who are often members of the management team) invested in the company (see skin in the game) and 2) they desire that their investment help to fuel the growth of the company not simply enrich an earlier investor in the company. By buying stock from the company, the company receives much needed cash to grow. If the Venture Capitalists simply bought out individual shareholders, the individual shareholder would receive cash but the company may still need investment.
For all of these reasons, it is difficult for entrepreneurs to sell their equity in their new ventures except during special moments called liquidity events. These are times when they are able to sell their equity. A specific type of liquidity event is called an "exit." This is where the an entrepreneur or investor is able to sell all or most of their equity--thus "exiting" the business. These are usually happy events where investors and entrepreneurs "harvest" in cash (or other liquid assets like tradable stock in another company) the value of years of work.