What is a Liquidity Event?

A liquidity event is the mechanism that turns ownership into cash. In the context of a startup, it is an acquisition, merger, initial public offering (IPO), or other action that allows founders and early investors to cash out some or all of their ownership shares.

For most of a startup’s life, the value of the company is theoretical. You might raise a round of funding that values your business at ten million dollars. On paper, your stake is worth millions. However, you cannot spend that money. You cannot buy a house with private stock certificates. Your asset is “illiquid.”

The liquidity event is the moment that asset becomes “liquid.” It is the point where the lock on your equity is broken, and you can exchange your risk for currency. For venture capitalists, this is the finish line. It is the only way they can return money to their own investors.

Not all liquidity events look the same. They generally fall into three categories, each with different implications for the founder.

• Acquisition (Trade Sale): Another company buys your startup. This is the most common outcome. The buyer might pay in cash, or they might pay in their own stock. If they pay in stock, you are trading one equity for another, hopefully more liquid, equity.
• Initial Public Offering (IPO): The company lists on a stock exchange. This allows the general public to buy shares. However, founders are usually subject to a “lock-up period” (often six months) before they can sell their shares.
• Secondary Sale: This is a partial liquidity event. Instead of selling the whole company, a founder or early employee sells a portion of their private shares to a new investor while the company stays private. This is increasingly common for late-stage companies staying private longer.

Founders often wonder why there is so much pressure to exit. If the company is profitable and growing, why sell?

The answer lies in the business model of your investors. Venture capital funds have a lifespan, typically ten years. They deploy capital in the first few years and need to return that capital plus profit to their limited partners by year ten.

Because of this structure, investors essentially require a liquidity event. They cannot hold your stock forever. This creates a natural tension. The founder might want to keep building for twenty years, but the investor needs a liquidity event in seven. Understanding this dynamic is crucial for managing your board of directors.

It is important to distinguish between a company being cash-rich and a founder having liquidity.

A company can be incredibly profitable, generating millions in free cash flow, while the founder remains illiquid. Unless the company issues dividends (which high-growth startups rarely do), that profit stays inside the corporate bank account.

Conversely, a company can be losing money but still achieve a massive liquidity event if an acquirer sees strategic value in the technology or the team. The financial health of the business and the liquidity of the shareholder are two different things.

Just because a liquidity event occurs does not mean the founder walks away immediately. In an acquisition, the deal often includes an “earnout” or retention package.

The acquirer wants to ensure the team sticks around to integrate the technology. They might structure the deal so that you only receive the full payout if you stay employed at the new parent company for two or three years. In this scenario, the liquidity is triggered, but the payout is delayed.