How do Liquidity Events work in private companies?

In this article, you’ll learn the basics of liquidity events and the risks that follow.

There are many business problems to consider before a liquidity event in private companies, such as determining what form of liquidity event is best for you, as well as negotiating potential terms and conditions. Keep in mind that each deal is unique, but the challenges that must be addressed are the same. In order to ensure a successful transaction, you will frequently be told to surround yourself with an experienced team. In this article, you’ll learn the basics of liquidity events and the risks that follow.

Liquidity event in private companies

Liquidity event is nothing but Illiquid assets, such as stock, which are converted to cash and paid to firm owners and investors. Assets that may easily be converted into money, such as cash on hand and accounts receivable, are included in a company’s list of “liquid assets”. IPOs (initial public offerings) and acquisitions by other corporations or private equity firms are liquidity event examples.

What is a liquidity event?

As an exit strategy, liquidity events allow company founders and early investors to sell their shares for cash. Investors who made early investments in a company and have seen the value of their equity decline may often look to sell their shares in a company in order to recoup some of their losses. Some founders may fear a liquidation event, but investors see the financial benefits as worth the risk.

How do liquidity events work?

There are a number of ways in which companies might employ liquidity, such as investing in other businesses or mitigating financial risks. As a result, the ability of businesses to take advantage of opportunities is directly tied to their liquidity. Companies and their stockholders are better able to take advantage of opportunities if they have cash on hand or easy access to funds. There are a number of liquid assets that individuals and businesses have access to, such as checkable accounts, cash, and savings accounts. Equity investment or continuing business funding requires this kind of cash.

Examples of liquidity events

Among the company’s key shareholders are Mark Zuckerberg and the other co-founders, as well as several venture capital firms. A liquidity event led to the creation of Facebook. The IPO raised $16 billion for the firm, making it a $104 billion publicly-traded company. At the time, Mark Zuckerberg was Facebook’s largest stakeholder, holding 28.2% of the company’s stock, which was then valued at $29.3 billion. As a result, companies like DST Global and Accel Partners joined Mark Zuckerberg in expanding Facebook’s cell and increasing its bandwidth through additional funding. In addition to the typical liquid event, significant corporations’ initial public offerings and direct acquisitions are also accessible.

Tender offer and liquidity event

Before a company goes public, there are a number of ways in which private companies can provide a liquidity event for employees and investors. A tender offer is one of the most prevalent methods of acquiring a business.

A tender offer is an organized, company-sponsored liquidity event. When several shareholders sell their shares in a tender offer, it is common for those shares to be sold to an investor or the firm. The company helps buyers and sellers find each other, finds a market price, and creates all of the disclosures and paperwork necessary to complete the deal.

For example, a “share buyback” is often known as a company’s acquisition of the shares, whereas an “investor purchase” is typically a company’s acquisition of the shares. Sellers benefit from tender offers because they can get cash for their shares. Using tender offers to limit dilution and recruit and retain top people is a win-win situation for both corporations and their shareholders.

Why do companies have liquidity events?

A liquidity event is most often linked with entrepreneurs and venture capital firms cashing out on their seed or early-round investments. Listed below are a few reasons why companies have liquidity events.

  • To attract employees – A public company’s equity is considerably easier to evaluate than a private company’s equity when an employee has the choice of two employment offers, each of which includes equity. The value of a publicly-traded stock can be accessed by anyone. In addition, the company’s stock is a liquid asset: When the stockholders’ equity vests, that equity is worth as much as cash. In order for private enterprises to compete with public companies for talent, they must offer liquidity. Liquidity events can help private organizations compete for employment by making them more attractive to potential employees. In addition, they may encourage current employees to stay at your organization for a longer period of time as well.
  • Control DilutionDilution is a major concern for current investors, company founders, and workers of private companies when it comes to obtaining new capital. There is a delicate balancing act that must be struck when a company is looking to raise additional capital. There’s a strategy you can use if your company has enough cash on hand. Using tender offers to attract new investors or allow existing investors to expand their stakes without diluting the company’s shareholders is one approach to use them as an anti-dilution weapon. Investors and workers will be able to cash out on some of their stock as you plan to go public.
  • For investment and investors – There are several situations where a company’s founders may not want to see a liquidity event, but investors certainly do. Liquidity events may not be a motivation for founders. Some founders have consciously rejected efforts from early investors to take a firm public out of fear of losing control or damaging a good thing. There is usually a short-lived phase of resistance.
  • M&A activities – Various financial activities, such as mergers, acquisitions, consolidations, tender offers, purchase of assets, and management acquisitions all fall under the umbrella term of merger and acquisition (M&A). Investors and founders can get their money back when the firm they invested in goes public through an acquisition or merger.
  • IPO – An initial public offering (IPO) turns a privately held company into a publicly-traded one, increasing the value of its stock. “Liquidity value” is a term used to describe the value of a company that has a high level of liquidity.

How to minimize liquidity risks?

To get the most out of any exit strategy, it must be meticulously planned and implemented. Many corporate investors fail to design their companies’ liquidity operations, which leads to undervaluation. A liquidity event clause is a key step for every firm, regardless of whether it’s a sale, IPO, private equity, or leveraged recapitalization. Listed below are a few pointers on how to minimize liquidity risks.

Business valuation

Liquidating a company requires an accurate assessment of its intrinsic and comparative value. During this negotiation, the most important negotiating chip is information on asset shares and the current ratio. Price-to-sale, price to growth, and P/E ratios can also assist you to determine the true value of your business.

The following are the most effective methods for valuing a business:

Beyond the monetary value of your business, there are other factors to consider in the valuation process. To get more precise numbers, you can use the correct tactics.

Find potential buyers

It can take anywhere from a few days to a few years to find a buyer. If your business is performing poorly or operating in an uncompetitive market, it might be difficult. Your company’s environment has a significant impact on whether or not customers will stop by.

The ideal buyer for your business necessitates both a strategic and personal network. Customers can include anybody from a direct rival to an ecosystem partner and anything in between. The investments of private equity and hedge funds in your industry may turn out to be more secure. To retain customers in your domain, you must master the art of communication. You should seek out investors in your field and stay in touch with them so they know how your firm is progressing. An important part of a successful investment strategy is keeping investors engaged.

Prepare for financial audits

Getting your financial records in order is essential if you want to liquidate your business swiftly. It helps to avoid any potential issues that may arise. A third-party, unbiased auditor should be hired even if your financial department appears to be trustworthy.

Company owners that primarily depend on internal audits during liquidation tend to have disastrous outcomes. Because of business interests, coverups, and a lack of independence, internal appraisal functions may not be totally trustworthy. Third-party audits can provide you with the greatest level of assurance.

Increase potential team

Liquidation can quickly turn into a stressful and difficult process. It’s possible that it’s out of your control and knowledge. The stress of brainstorming and planning multiple projects might be lessened by assembling a team of consultants. If you want to protect your long-term investment and your equity, you need the support of significant players.

Your company’s earnings could be negatively affected if you don’t plan for a liquidity event from the start because the process is so time-consuming.

Legal, financial, and liquidation expertise all need to be part of your team. With an all-inclusive team, the outcome of the liquidation event can be greatly improved. As part of IPO preparation, debt restructuring, and sophisticated business valuations, financial managers can offer assistance. A lawyer can guide you through the legal issues of your company’s operations as well as serve as a sort of curator.

Always go at the right time

Many business owners overlook the significance of timing. Liquidity and equity could suffer if investors do not pay attention to business cycles. When it comes to maximizing a liquidity event, time is everything. It’s ideal to liquidate when business is booming and there are few risks involved. You should not underestimate the importance of good timing as a value generator. An enormous amount of equity is lost by companies that don’t plan ahead of time.

Things to consider before running liquidity events

  • What are your most important business objectives (i.e., short-term cash flow, long-term value, and ongoing business control) and how do they compare in terms of importance.
  • If an IPO is envisaged as a source of liquidity, management should be upgraded, with a particular emphasis on the CFO and the company’s internal financial reporting capabilities.
  • It’s important to have an experienced deal lawyer and/or transition lawyer in place as key business counsel so that there are no surprises when the transaction begins.
  • An experienced accounting firm can perform an audit for at least one year prior to a transaction and assess revenue recognition as well as a company’s depreciation and amortization policies (note: an IPO requires three years of audited financial statements).
  • In order to protect essential intellectual property assets, seek a license to use any key intellectual property that is not owned, assign any rights possessed by affiliates that were not previously assigned to the Company, and register trade names as trademarks.
  • A possible liquidity transaction may necessitate changes to important commercial and investment agreements.
  • Prior to conducting due diligence on the liquidity event transaction, verify the sufficiency of minute books, stock books, and other corporate records. There are tax consequences for companies that don’t keep accurate records of their transactions.
  • Prevent compensation costs associated with “cheap stock” by setting reasonable, fair market value exercise prices for option grants.
  • Take into account adding independent directors to the board of directors, particularly when the planned liquidity event is an initial public offering (IPO). Make sure you’re covered for directors’ and officers’ liability.
  • Consider personal estate planning before engaging in liquidation activities and the subsequent “step-up” in value.

Eqvista provide a high-quality business valuation for every stage

Successful implementation of these approaches will not only decrease liquidity risks but also increase profitability. Your company’s marketable qualities, attractiveness, and overall worth will improve if you follow these pointers carefully.

In the event that your company’s cap table is on Eqvista, setting up an Eqvista tender offer is quick and easy. There is no need to learn a new system with tender offer providers. Eqvista’s team of experts helps you and your shareholders get the deal done. Using our platform, we collect orders from participants, settle the transaction, and instantly update your cap table when it’s done.

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