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Liquidity Events: How Angels Make Money
In a liquidity event (or exit), the company in which you invested is sold or the company goes public, allowing investors to cash out of their investment.
Acquisition is a kind of liquidity event that occurs when a company buys at least a controlling interest in another company, for cash or stock of the acquiring company or a combination of the two. Being acquired by another company is the most common outcome for startups, excluding total failure. In 2018, 90% of the exits were acquisitions, while 10% were IPOs*.
Often startups—which are all private companies—are acquired by public companies, in which case the startup’s investors will get either cash or shares in the public company. But the investor may not be able to cash out on those shares right away—they may be subject to a lockup agreement.
A lockup agreement is an agreement with the issuer of the securities (the company) that you will not sell your shares for some period of time, sometimes for as long as a year.
If the shares in the public company are not subject to a lockup agreement, then the shares will be tradeable on the public markets.* If the acquiring company is another private company, and they use their shares rather than cash to buy the stock of your portfolio company, then after the transaction you will own different shares that you still cannot sell. You will have to wait for the acquiring company to be sold or go public.
Initial Public Offering
Acquisition is not the goal of every startup—many hope to eventually make it to an IPO.
An initial public offering (IPO) is the first sale of a company’s stock to the public where the sale is registered with the Securities and Eschange Commission, specifies an initial trading price for the stock, and is generally financed by one or more investment banks.* This type of liquidity event is colloquially referred to as “going public.”*
Early investors may have a lockup period of three to six months post-IPO, after which they will be able to sell their shares and reap the rewards of their early-stage angel investment.
important While IPOs typically represent the largest multiple in terms of return on investment for an angel investor, it is almost always a long wait to get there—11 years on average in 2020. Companies typically need to be of significant scale (hundreds of millions of dollars of annual revenue) with robust, profitable businesses to be able to bear the burden of the significant regulatory, legal, and accounting expenses of being a public company, and to be able to engage the investment bankers who will underwrite the offering and guide the company through the rigorous IPO process.
There has been some movement in recent years toward trying to make shares in private companies more easily saleable even in the absence of a public market transition. For example, in 2015 Congress enacted Section 4(a)(7) of the Securities Act of 1933, enabling secondary transactions in non-generally solicited exchanges with an accredited investor buyer.* However, secondary market transactions in private company shares are still rare, and you should not expect that this will be a ready source of liquidity for you.