Anatomy of a Term Sheet - Redemption

You sometimes see investment deal terms which, contain redemption provisions. Redemption is another method through which Investors can seek to “exit” from their investment if there has been no other “exit” opportunity within a set period of time (for example five years). Redemption rights are essentially a put option, giving the Investors the ability to require the company to buy back the Investors’ shares at a previously agreed-upon price. It is rare for Investors to exercise their redemption rights and in any event, if it gets to the stage that the only way the Investor can “exit” the company is through redemption, the company has bigger problems. Redemption mechanics are difficult to trigger in the UK, as legally the Company needs to be profitable (or have distributable reserves) before it can redeem its shares.

Companies should be aware that agreeing to redemption can cause accounting issues. Under UK accounting practice some redeemable shares (particularly those which carry a preferred dividend) may be required to be treated as a debt on the company’s balance sheet. This can cause problems when dealing with new customers or suppliers when they see that you have a large debt on your balance sheet.

The Anatomy of a Term Sheet series can be found in full here