Awkward Liquidity
It’s always a little awkward when someone shares an oddly specific hypothetical scenario and then asks you how you might handle it if (when?) it comes to pass. For example, a common question we get when we propose to purchase a majority – but not all – of a company from someone is: “I get that you guys have a 30-year timeframe, but I may not. What happens if I want or need to sell shares some time in the future?”
And that’s a very fair question. When it gets awkward is when someone asks it by saying something like, “Let’s say in 10 years I’m having some kind of mid-life crisis and want to buy a fighter jet and learn how to fly it or a bunch of land – or a missile silo – and move off the grid. How would I get liquidity then?”
While there’s a lot more to unpack when phrased in the latter manner rather than the former, either way our answer is the same.
First, we say, it’s hard to predict the future, so while it might seem comforting to codify a bunch of items anticipating such situations, we think all of our time is better spent diligencing one another in order to reach the conclusion that we are all reasonable people. If that’s true, then the best course of action will be to take the future as it comes and negotiate a transaction as reasonable partners when the time comes given the facts as we know them then.
And while I do think that’s the best course of action, I also accept the fact that it’s difficult for someone who just met us to take that at face value and move forward if they really do have a concern.
So, second, we say that because of the way our fund and fee model work, we are typically paying out dividends semi-annually, which makes our fund much more liquid than the typical private equity vehicle. Given that, if you model it out based on your forecasts, it may be the case that even without selling anything, you’ll have all the liquidity that you need. And we encourage them to do that.
But, third, if your dream is to own a fighter jet or a missile silo and you want guaranteed peace of mind that you can get the money to acquire one if and/or when you want to, then we can write a put option into the operating agreement. This put option would force your partner or your company to buy back your shares at the time of your exercise subject to different terms and conditions. We then point out, however, that this situation would be a little awkward. After all, partners typically aren’t forcing their partners to do something if it’s a healthy partnership, so any guaranteed put option will probably come with some punitive terms (such as being priced at a depressed valuation) in order to make it fair to both sides (remember that certainty is expensive).
That’s important to point out ahead of time, of course, because it means that no one will be surprised or upset when they read it in the docs. But…it’s still a little awkward.
– Tim
