What is a liquidity event in angel investing?
Updated: 5 days ago
If you invest in startups, illiquidity is your biggest adversary.
You can't sell startup shares whenever you want. Unlike shares of public companies that you can buy and sell on stock exchanges, you have to wait for a liquidity event to sell the shares you own in any startup.
Startups are private companies. They don't trade on public stock exchanges. Whenever a startup needs growth capital, it goes out into the private market to raise money from VCs and other investors. If its performance is good, investors buy its shares. The startup gets money, and the investors get shares.
This is an example of primary (new) shares. Existing investors (angels) who invested at lower valuations don't get to sell their shares unless the startup raises a large round of Venture Capital.
In such cases, new investors offer existing investors like you an opportunity to sell their shares. This is an example of a liquidity event. This act of shares exchanging hands between old and new investors is a secondary transaction.
Most secondary transactions happen once the startup has become reasonably big (raised $10M+ in Series B round). And most secondary transactions happen at a discount. When the startup raises fresh capital of $10M in Series B at a $30M pre-money valuation ($40M post-money), angel investors won't be able to sell their shares at this $30M valuation.
New investors (VCs) offer to buy Angel's shares at a discount of 10% to 50%. The venture funding market determines this discount. If the money supply is easy, the discount is low and vice-versa.
As an angel investor, you won't have to wait for the IPO to sell your shares. You will get opportunities before that once the startup becomes large and raises big capital from VCs.
Here's an example of the journey of an angel investor.
In the seed round, he invested $20,000 at a $2M post-money valuation. He sold his shares at a 30% discount when the startup raised its Series B at a $40M post-money valuation.
His net return (minus dilution and discount) was 6.3x. For the angel investor, this was a mild success. He didn't make a 20-30x return but didn't lose his capital.