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allow a stockholder to convert his investment in stock or debentures into cash. They usually appear as provisions in a written contract between a company and its investor. Liquidity agreements are common in venture capital financings, particularly when the investor is uncertain whether the company will ever be able to offer its stock for sale in the public markets (i.e. "go public"). Since many venture capital investments end up being less successful than the business plan predicted, these options can be very important to investors. Common liquidity agreements include puts, which enable an investor to force a company to repurchase his shares for an agreed-upon price, and buy-sell agreements, which enable an investor to force management to either purchase his shares or sell its shares to him. These buy-sell arrangements make it easier for an investor to liquidate his investment even when management chooses to sell its shares. This is because it is usually easier to sell a controlling interest in a company than it is to sell a minority interest (which is what most outside investors hold). Convertible debentures also increase investor liquidity and provide an escape when a company is not living up to expectations. They do so by giving the investor the option of not converting his debenture into shares of the company’s common stock. If the company does not do well enough to give the investor a "healthy" profit upon the sale of the common stock he could obtain by converting his debenture, the investor can choose to forgo converting to the company’s stock and collect instead the interest and principal repayment on his debenture. Demand registration rights that enable an investor to force a company to register his shares for sale are also a form of liquidity agreement. Debentures and promissory notes used in a financing structure provide liquidity by allowing investors to withdraw a part of their investment as a nontaxable return of debt. Any agreement that makes it easier for investors to get their money back is a liquidity agreement. All liquidity agreements should be considered carefully before they are agreed to. Many, in creating liquidity for an investor, creates a corresponding company need for funding. If the provisions are not carefully considered, this need for funding could come at a time when it is particularly costly or unavailable. In this situation, a liquidity agreement could cripple a company or even force management out. See: Buy-Sell Agreements, Cashing Out (or In), Convertible Securities, Co-Sale Agreements, Debentures, Demand Rights, Exits, Financing Agreements, Piggyback Rights, Puts, Registration Rights, Structure. |
