The illiquidity premium is the additional return investors require to compensate for holding assets that cannot be readily converted to cash.

How it works

Public market investors can sell shares on demand. Private equity and venture capital LPs commit capital for years — often a decade — with unpredictable distribution timing. Secondary markets exist but are limited, discounted, and selective. Rational allocators therefore demand higher expected returns from illiquid strategies than from liquid public equivalents. The premium is not a fixed number; it varies by strategy, vintage, and market conditions. In frothy periods when public multiples soar, the illiquidity premium compresses because private marks lag or look cheap. In downturns with frozen IPO windows, the premium expands as LPs reassess whether lockup is worth it. Founders experience illiquidity through their own equity — shares have no public market until an exit event.

Why it matters

• Investors / LPs: Portfolio construction weighs illiquidity against diversification and return targets. Underperforming private allocations lose favor when the premium is not earned.
• Founders: Understand that your investors’ cost of capital includes illiquidity. That shapes return hurdles and exit pressure over fund life.

Common mistake

Assuming private market outperformance is pure alpha. Part of reported VC outperformance historically reflected illiquidity and valuation smoothing, not just skill.

Related ideas

J-curve, secondary market discount, hold period, and public-private valuation gap relate to illiquidity pricing.