What is a Liquidity Event?

‍[ BACKGROUND COLOR BLOCK-1 ]

• Liquidity events allow venture investors to convert their ownership stakes in a startup into cash or liquid securities.
• Liquidity events can include a startup going public, getting acquired, or a venture investor selling their stake on a secondary market.
• Terms like the investors’ liquidation preference and other protective provisions can impact the payout from a liquidity event.

‍[ /BACKGROUND COLOR BLOCK-1 ]

In 2014, Facebook acquired the messaging app company WhatsApp for $21.8 billion. One big winner of this acquisition was venture investor Sequoia Capital, which turned its $60M stake in WhatsApp into $3B—a solid 50x return.

Five years later, ride-hailing pioneer Uber went public at a $75.5B valuation. VC firms First Round Capital and Lowercase Capital—both of whom had invested in Uber nine years earlier during its seed round at a $4M valuation— saw spectacular returns. First Round Capital had its $510K stake become $2.5B, while Lowercase Capital saw its $300K stake turn to $1.1B.

WhatsApp’s acquisition and Uber’s IPO are both examples of massively successful exits for venture investors, founders, and employees of the company (assuming those employees had equity). Such exits also have another, more technical term—liquidity events. In this article, we’ll dive into liquidity event details, including the types of liquidity events and what both investors and founders should understand about them.

What is a Liquidity Event?

Venture capital investments are illiquid assets, meaning they cannot easily be converted into cash. A liquidity event is the “end game” of a venture capital investment—the point where the investors see their investments converted into liquid assets, hopefully for much more than what they put in. 

These liquid assets are not necessarily cash—they can be in the form of publicly traded shares as well. For instance, the WhatsApp acquisition was done primarily through Facebook stock. 

Liquidity events come in three primary forms:

• Going public. A startup is said to “go public” when its shares can be freely traded on a public stock exchange, such as the NASDAQ or NYSE. There are several ways for a startup to do so, with IPOs being the most common form. Venture-funded companies like Roblox and Coinbase chose to go public via direct listing instead—where only outstanding shares are sold (with no new shares created), and no underwriters involved. Merging with a Special Purpose Acquisition Vehicle (SPAC), which is already publicly listed, is another option. Startups like fintech firm SoFi have opted for the SPAC route. After the startup goes public, existing investors may also be subject to a lockup period—during which they cannot sell their shares. In such cases, the investors may have to wait anywhere from 90 days to a year before being able to sell their stake.
• Getting acquired. While high-profile public listings may attract the most attention, PitchBook data shows that acquisitions are still the most common liquidity event for VCs. While acquisition deals are generally much smaller than public listings, there have been notable exceptions (e.g., the WhatsApp acquisition). Others include Square’s $29B acquisition of Buy-Now-Pay-Later platform Afterpay and PayPal’s $4B acquisition of shopping platform Honey. 
• Secondary market transactions. In some instances, specific investors may be able to sell all or a portion of their ownership stake to a new or existing investor without the startup itself going under a change of control. It’s a liquidity event for the seller without being a true exit for all investors. For example, a startup with three co-founders has one co-founder sell their stake to the existing venture investors (who chose to exercise their rights of first refusal).

When Do Liquidity Events Occur?

Considering most VC funds have a 10-year lifespan with the initial investment period being 3-5 years, it’s safe to say that most venture investors generally expect a liquidity event to occur between 5 to 10 years. According to Statista, in the United States, the median time taken between the initial VC investment into a startup and it going public is 5.7 years. In 2020 (the most recent data available), it was 5.3 years. 

Of course, there will be substantial variation depending on the startup, its industry, exit type, and prevailing market conditions. For instance, Pitchbook notes that the most common startup liquidity event—acquisitions—is now happening at earlier stages. In 2021, most acquisitions have come directly after a seed or Series A round. Meanwhile, the data shows most startups do not go public until after their Series C.

What Investors Should Know About Startup Liquidity Events

Although startup liquidity events are a primary motivation of many venture investors, investors should be aware that:

• Founders may not necessarily share the same motivation. Founders may have different incentives than investors with respect to liquidity events. For example, many founders stay with the acquiring company to help run the product line and achieve earnouts or management incentives.
• Other venture investors may have different views on what the ideal liquidity event is. What happens when an acquisition offer is put on the table, but not all investors agree? Some investors may be willing to wait years more until a big IPO—others may be looking for a smaller, but quicker, exit. What the “ideal liquidity event” is for a VC may differ depending on where the fund is in its lifecycle, how the rest of its portfolio is performing, and the terms of the specific deal. 
• Properly negotiating liquidation preferences, seniority, protective provisions, and drag along rights is crucial. The liquidation preferences and seniority of each investor can significantly influence their view on prospective liquidity events. For instance, an investor with a 2x non-participating liquidation preference may be more amenable to acquisition offers (as long as the sum is sufficient to fund their full liquidation preference). Meanwhile, protective provisions are what give investors power to veto potential liquidity events. And drag along rights can be used to compel minority investors to go along with a liquidity event. Negotiating—and understanding—all these deal terms is crucial.
• The prospects of liquidity events can be highly dependent on the state and sentiment of the broader market. In 2020, VC liquidity events totaled a record $289B. But in 2021, that figure nearly tripled to $774B. Rising corporate valuations, investor enthusiasm for tech companies, and low interest rates were all possible reasons for this. 
• The regulatory environment can also affect liquidity events. Broader market aside, the prospects of liquidity events are also subject to regulatory risk. For example, a planned $5.3B merger between Visa and Plaid was called off after the Department of Justice filed a civil antitrust suit to block the merger. There is also a proposed antitrust bill that would block all acquisitions by companies with a market cap of over $100B—something which could severely undermine acquisition-based liquidity events. 

Liquidity Events: An End Goal for Venture Investors

General partners (GPs) and limited partners (LPs) alike can only realize profits after liquidity events. The GPs can earn carried interest from them, and they’re the source of all distributions to LPs. But liquidity events are not “one size fit all”—nor is the path toward achieving them necessarily so straightforward.