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Redeemable Shares Explained

Redeemable Shares

Redeemable shares are a flexible type of share that allows businesses to buy back the shares in the future. Whilst the business doesn’t have to repurchase the shares, they have the option to buy based on pricing conditions set when the shares are first issued.

Redeemable shares provide a way for a business to gather investment upfront via the sale of shares, but with the clause, that they can be repurchased at a later date in return for cash or assets.

The main difference between a redeemable share and a regular share is that the company selling the shares and the purchaser agree on the price and terms for the buyback of the shares at the point of sale. The benefit of this type of share is that it offers flexibility for companies to reorganise their capital based on business needs.

Read on for more details on redeemable shares including how they can be used by businesses and investors. 

An Introduction To Redeemable Shares

This type of share comes with the option for the company that has issued the share to buy it back from the shareholder in the future. The terms of the buyback are set at the point of the sale and this allows company directors to redeem the shares based on the conditions set then they need to.

Companies choose to issue redeemable shares over common shares due to the flexibility in capital generation they provide and the ability to stay in control of their shareholder relationships.

The terms of a redeemable share can be customised to suit the individual’s business objectives. For example; raising venture capital to scale high-growth startups.

If a startup needs to raise venture capital funding, the venture capital invests $ 5 million in return for redeemable preferred shares with a redemption trigger when the company reaches a liquidity event like a trade sale or IPO in the future.

This win-win scenario means that the startup gets the funding it needs to push through its expansion and growth plans and the VC investors have a clear exit path to cash out the returns from their investment. The other key benefit is that the start-up doesn’t need to dilute the business control as it would if issuing common shares.

Why Do Companies Issue Redeemable Shares?

The buying and selling of shares is a strategic investment move that comes to make money and retain control of business ownership. Some of the key benefits associated with redeemable shares are:

Flexible Capital Structure

Being able to raise capital that can leave the business in the future when conditions are triggered is the fundamental premise of a redeemable share. This increased flexibility for being able to reshape the capital structure of the business is in contrast to the permanent capital generated from common stock.

Future Exit Strategy

Future redemption dates and repurchase terms are agreed upon with investors upfront. This means that investors have a better understanding of how they can and when they will be able to liquidate their shares.

Control Mechanisms

Redeemable shares can be issued with or with voting rights attached to them. This means that capital can be raised without the need to dilute business control or decision-making powers for the existing owners.

Motivate Employee Shareholders

When missing redeemable shares to employees, they can act as an incentive that’s tied to performance. This could make them want to stay longer and work harder toward specific goals that would mean they’re able to get their money back when they leave the company.

What Limitations Are There For Redeemable Shares?

There are limitations around the percentage of total shares issued, the procedure around the issuing of shares and the disclosure requirements that companies need to be aware of.

Percentage Limits

There are limits on the maximum proportion of share capital that redeemable shares can make up.

For example, public companies can’t have redeemable shares that account for more than 50% of the total share capital based on the nominal value of shares issued.

Private companies have more flexibility though as redeemable shares can make up 100% of their share capital if preferred.

The key concern for public companies is that if more than 50% of shares were able to be bought back, this could cause instability for the business and impact public confidence.

Issuing Procedure

A company’s Articles of Association need to have a specific authority included within it for redeemable shares to be issued. Without this clause, the Articles of Association can be amended to include it, but the change must be passed through a formal agreement of directors.

When redeemable shares are offered, the rights, terms and conditions associated with them must be set out and filed with regulatory authorities.

Details to be included here are redemption dates which could be fixed or based on a trigger event, the way the redemption price will be calculated, how notices will work and the overall process for repurchasing.

This is to ensure that both parties fully understand the terms and mechanics involved in the buying and selling of redeemable shares.

Disclosure Requirements

If a public company or a private company issues redeemable shares, they must have a detailed prospectus that outlines everything about the share redemption rights.

Maining ongoing disclosures is key too because any subsequent change in share capital triggered after share redemptions must be filed and updated with Companies House.

The disclosure needs to mean that all terms surrounding the buyback of redeemable shares must be made clear to all parties in advance to avoid any issues or confusion in the future.

Shareholder Rights And Redemption Processes

It’s important for both issuing companies and investors buying shares to understand the rights attached to redeemable shares and the procedures for redemption. This includes voting and dividend rights, director approvals, notices and cancellation of shares.

Voting and Dividend Rights

Redeemable shares can be issued with or without voting rights and if any rights are included, they will be set out in the Articles of Association.

Directors Approval

Once trigger events or redemption conditions are met, the company directors will need to pass a board resolution that officially approves the decision to redeem the shares. This process acts as a checkpoint to confirm that there are enough funds available within the organisation to allow the redemption to be completed.

Notifying Shareholders

When shares are going to be redeemed, the shareholders must be notified by the company in advance. The period of this notice period must be outlined at the point of issue and included in the Articles Of Association.

Cancelling Redeemed Shares

When a redeemable share(s) have been traded in for cash or assets, as per the terms of the share, there is an administration task that needs to be completed. This is to update the official company records held with Companies House that outline who the shareholders are. This may mean that new share certificates need to be issued.

How Are The Shares Treated For Tax And Accounting Purposes?

As either a purchaser or issuer of shares, it’s important to understand the implications for tax and accounting purposes to ensure that investors and businesses are correctly reporting and understand what their share ownership means and how any income derived from them should be reported.

In company accounts, income from redeemable shares is treated as equity. This changes to a liability when the redemption trigger occurs and shareholders need to be paid.

If the repurchase price exceeds the amount the share was purchased for, the difference can be considered taxable income for shareholders instead of capital gains.

Any share premium and impact on reserves should be reviewed against benefits like flexible capital structure, investor incentives offers, and alternative exit routes for shareholders. This will help to determine if any perceived advantages outweigh the costs.

Always seek the services of a qualified accountant to ensure that proper record keeping is maintained and decisions are based on accurate business finances.

When Is It A Good Idea To Use Redeemable Shares?

Redeemable shares offer flexibility not available for other types of stock which means they’re particularly useful in certain business scenarios including;

Early stage startups

In the early stages of set-up, businesses can benefit from redeemable shares to get the funding needed whilst retaining control of the company as it grows.

Family Companies

If family-owned companies need to bring in external investment from non-family members, they may want to use redeemable shares to keep family ownership alive.

Mature Companies

Mature companies with healthy cash flows can use this type of share to make tax-efficient transactions when needed. As they will be able to issue and buy back shares promptly due to having a healthy bank balance. This means that they can leverage buyback programs that help to distribute surplus capital held in the bank to shareholders in a tax-efficient way.

Frequently Asked Questions About Redeemable Shares

What Are Shares?

Shares are units of ownership in a company. If someone owns a share or several shares, they have a stake in a company. That ownership comes with certain rights and returns depending on the type of share that is owned.

The total number of shares issued by the company will impact how much each share purchased represents in terms of overall company ownership for each shareholder. For example, if 100 shares are issued and person A buys 25 of them, they would be a 25% shareholder in the company.

What Are Articles of Association?

The Articles Of Association are important official documents that all incorporated companies are required to have as part of their registration with Companies House (The register of businesses in the UK).

The documents set out the rules, requirements and regulations around key areas including capital structure, share ownership, director/shareholder rights and procedures, and governance processes for the business.

Think of Articles of Association as an official handbook that details company-specific information on all the key components of its structure and key processes that it will go through in its remit of being a private or limited company.

What Kinds Of Shares Are There?

While we have focused on redeemable shares in this post, there are also common shares, preference shares and restricted shares available. Each has its rights and rules meaning they can be used for different strategic business needs.

  • Common shares are voting shares that offer proportional ownership and control in the company.
  • Preference shares take priority over common shares when it comes to dividend payments and other rights.
  • Redeemable shares as covered here provide a repurchase option by the company based on set terms.
  • Restricted shares have imposed restrictions upon their transfer

What Is A VC Firm?

VC stands for Venture Capital and this term refers to a firm that provides financing to early-stage startups and small businesses that have the potential for big growth. VC firms raise capital from investors and then invest that money into startups in exchange for shares. This is a high-risk financing method that can have huge rewards for those willing to invest.

Summary Of Redeemable Shares

To recap, redeemable shares provide a way for companies to raise capital by issuing shares that they can buy back at a later pre-defined time / or after a trigger event has occurred. They offer a way for businesses to strategically adjust their capital structure based on their current and evolving needs.

Redeemable shares can be useful in startup funding, helping established companies to return surplus capital to business owners and allowing investor exits for VC-backed firms.

Whilst a versatile tool for business financing, they need to be managed carefully with their terms and conditions properly recorded on the Articles Of Association at the point they’re issued.

 

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