What is the significance of liquidity to stock corporations?
danger With private companies, it can be very hard to know the value of equity. Because the value of private company stock is not determined by regular trades on public markets, shareholders can only make educated guesses about the likely future value, at a time when they will be able to sell stock.
After all, private company stock is simply a legal agreement that entitles you to something of highly uncertain value, and could well be worthless in the future, or highly valuable, depending on the fate of the company.
confusion We’ll discuss the notion of a company officially assigning a fair market value later, but even if a company gives you a value for your stock for tax and accounting purposes, it doesn’t mean you can expect to sell it for that value!
Definition An acquisition is the purchase of more than 50% of the shares of one company (the acquired company) by another company (the purchaser). This is also called a sale of the acquired company. In an acquisition, the acquired company cedes control to the purchaser.
Definition The ability to buy and sell stock is called liquidity. In startups and many private companies, it is often hard to sell stock until the company is sold or goes public, so there is little or no liquidity for shareholders until those events occur. Thus, sales and IPOs are called both exits and liquidity events. Sales, dissolutions, and bankruptcy are all called liquidations.
Often people wish they could sell stock in a private company, because they would prefer having the cash. This is only possible occasionally. We get into the details later, in our section on selling private stock.
Definition A dividend is a distribution of a company’s profit to shareholders, authorized by the board of directors. Established public companies and some private companies pay dividends, but this is rare among startups and companies focused on rapid growth, since they often wish to re-invest their profits into expanding the business, rather than paying that money back to shareholders. Amazon, for example, has never paid dividends.