When you raise money from investors, many of them will want to know how they may someday get their money back out of your company.
When people invest in public companies, it is very easy to exit from one investment to another—they just tell their online broker to sell Apple and buy Google.
But with investments in private companies, the exit may not be so easy. If you offer debt to investors, the way they will exit someday is spelled out in your promissory note. At some point, you will pay your investors back their initial investment (principal) plus interest.
What if you offer an equity investment, however? In the venture capital model, used for high growth tech startups, the exit from an equity investment usually happens when the company is acquired by another larger company. But what if you don’t want to focus all your energy on that kind of exit? When you know your investors are expecting you to sell your company to the highest bidder as quickly as possible, you may be forced to do things that are not in alignment with your goals, values, and how you want to live your life.
What if your investors could exit without you having to sell your company? Well, they can! There are a few ways this can happen, but in this article, I will focus on redemptions. A redemption is when you buy equity back from your investors. You can build this into your investment terms right from the start so that both you and your investors are clear on how they may someday exit.
Your investor’s ability to redeem his or her stock will depend on the exact language you put in your legal documents. Our clients usually offer the ability for their investors to request a redemption at a certain predetermined price. If your company is unable to honor the request due to insufficient cash for operations and reserves, you can delay or refuse the redemption or can pay the redemption in the form of a promissory note. You can also offer a “mandatory redemption right” that requires the company to redeem the equity whenever the investor wants (this right often doesn’t kick in for several years after the initial investment). Keep in mind though that there is really no such thing as a truly mandatory redemption right. If your company does not have enough cash to meet its obligations to its creditors, it cannot legally redeem investor equity.
To learn more about all the ways that your investors can exit without you having to sell your company, consider joining our Capital on Your Terms Community—this is a great way to get literate about fundraising and make sure you know all your options for raising money on terms that will be sustainable for you and your business.