Part 1 of 2 – The Pros
The expression “liquidity event” is not necessarily well understood among the general population. Let’s take a look at it from the Family Business point of view.
Essentially, a liquidity event takes place when the owners of a business, in this case a family, sell a substantial portion of their business (either shares OR assets) to an outside party, for cash or another form of asset that can more readily be turned into cash quickly.
If the Smith family owns LMNOP Co., and strikes a deal to sell their shares to QRST Co. for $25 Million in cash, they have just experienced a liquidity event.
If the Smiths had merged LMNOP with QRST, or there was simply and exchange of shares that couldn’t be readily sold off, that is a different animal, and not a liquidity event.
In the sale example, the Smiths suddenly sitting on a big pile of cash, in the second, they are not. Their wealth is still not “liquid”.
Business = Not liquid
One of the big problems that a family owning a business can face is that while the owners may be “wealthy”, it’s actually quite difficult for those owners to realize the benefits of their wealth, because it isn’t in the form of cash they can spend.
Family members often face awkward situations, especially in a small communitiy where everyone knows that they own the big local company, and treats them as if they are rich, even though they are still struggling to make the mortgage payment on their modest home.
When considering your ownership of an asset, given the choice between illiquid or liquid, liquid will almost always be the better scenario. We’ll get to the exceptions next week, in the Cons blog.
Real Estate versus Publicly Traded Stocks
The assets that the family company owns also have their own liquidity considerations. As someone who lived this, here’s a personal example.
When my family had its first liquidity event in 1991, we sold our operating assets for cash, and kept the real estate, leasing the premises to the buyer. So we had partial liquidity, along with some more “solid” real estate.
Imagine the difference between owning 10,000 shares of Microsoft stock (worth approx $640,000 today) and a 90,000 square foot industrial building worth about 3 times that. Which would you prefer?
Well, don’t forget to ask which is more liquid. By the way, the building is on contaminated land.
I could sell the shares of MSFT in seconds, literally, with a click of a mouse in any online trading platform.
The time it took to divest ourselves of the property, however, was not measured in seconds, or even months. It was actually over a decade. Much less liquid, thankfully it was not our only asset.
Diversification Benefits
One of the best parts of a liquidity event is that it allows the owners to diversify their wealth into different asset classes, thereby reducing their risk.
If you own an orchard that represents 95% of your family’s wealth and there is a weather event, you better have good insurance, because almost everything you own is exposed to a risk that is difficult to control.
The Smiths, from above, with their $25 Million, can invest that money into a variety of asset classes that are (hopefully) not correlated, so some will go up and others down, but all in all they face much less risk.
True, their ability to grow those assets in a diversified portfolio isn’t as great as with the concentrated position in their business in an industry that they know well, but this week’s post is about the Pros of liquidity. Cash is much more flexible.
Liquidity of Each Owner
It’s easy to get sidetracked between the liquidity of the assets owned by the business and the liquidity each owner has for their shares; I was just guilty of that above.
Ideally, if I own 5 or 10 or 20% of my family business, it would be nice if I could sell it for what it is worth to anyone willing to buy it from me.
If you’re nodding your head up and down because that’s you, my first response is “Ha Ha Ha Ha Ha! Good luck with that”.
Please stay tuned for more on this next week.
To make sure you don’t miss it, please subscribe!
