A liquidity event refers to a transaction or series of transactions that provide investors, founders and employees with the opportunity to convert their equity interest in a company into cash. Shareholders' agreements typically provide a definition of a liquidity event, the details of which often vary. The parties should pay attention to these definitions, since liquidation preference is triggered in a liquidity event, i.e. liquidation preference outlines the payment hierarchy for shareholders during a liquidity event. Naturally, shareholders at the bottom of the liquidation preference waterfall (such as the founders) have an interest in a narrow definition of a liquidity event, while investors (particularly later stage investors) have an interest in a very broad definition of a liquidity event.
Common types of liquidity events:
1. Exit transaction
An exit transaction is an event where shareholders sell their shares in a company, leading to a change in ownership or control. This strategic move often occurs through an initial public offering (IPO). As an alternative to an IPO, an exit transaction is commonly structured through:
- an exit share transfer, involving the sale, exchange, contribution or disposition of shares to a single entity or a group of commercially related individuals;
- an exit asset sale, characterised by the sale of company assets followed by the distribution of proceeds to shareholders as dividends; or
- an exit merger, encompassing any consolidation, merger, business combination or transformation resulting in the initial shareholders collectively holding 50 % or less of the shares, equity rights, voting power or other interests in the surviving entity.
This pertains to the winding-up of the company, either voluntarily or compulsorily as part of an insolvency proceeding, leading to the distribution of liquidation proceeds to shareholders in the form of dividend payments (if any proceeds are left after the satisfaction of creditors).
2. Company liquidation
This pertains to the winding-up of the company, either voluntarily or compulsorily as part of an insolvency proceeding, leading to the distribution of liquidation proceeds to shareholders in the form of dividend payments (if any proceeds are left after the satisfaction of creditors).
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