Redemption provisions:
Trigger events are paramount to providing investors with security and ensuing them with the comfort of being able to exit their investment under carefully defined circumstances. Such trigger events commonly negotiated include the maturity date of the note without a conversion event occurring; where there is a significant change in control of the company; or, a failure by the company to meet revenue, growth targets or other financial metrics.Redemption provisions provide investors with a safety net for their investments. However, these provisions could be a double-edged sword for companies: while CLNs make it easier to secure investor funding by making investments more attractive, redemption provisions could also create cash flow obligations for companies, impacting their financial planning and requiring careful management.
Negotiation points:
Regarding trigger events, investors could seek clear and specific trigger events that allow them to redeem their investment. They may also strive to negotiate broader redemption triggers to provide greater security. Conversely, the company may pursue a narrower list of trigger events to maintain flexibility and manage their financial growth.Redemption premiums are beneficial for investors investing in start-ups with high-risk profiles, as the company would have to repay the loan along with a pre-agreed redemption premium. In contrast, the company would endeavour to eliminate or minimise redemption premiums to retain capital and control over their equity structure. Striking a balance is paramount in maintaining both security for investors and financial continuity and stability for the company.
Timing and notice periods are key points to consider when negotiating such provisions. The company may reasonably negotiate longer notice periods before any redemption rights can be exercised by investors, ensuring that they have adequate time to grow and manage cash flow. Conversely, investors may seek shorter notice periods to allow for a quick exit.
Investors may also seek further flexibility in redemption by negotiating a partial rather than a full redemption. This provides investors with the security of redeeming a portion of their investment whilst keeping the remainder in the company.
Companies also need to consider how redemption provisions affect future financing rounds, particularly in terms of debt seniority and subordination.
Conclusion
In summary, redemption provisions offer a mechanism for investors to mitigate risk while providing companies with the flexibility to raise capital without immediate equity dilution. Therefore, it is vital to strike a balance that protects both parties' interests and secures a mutually beneficial agreement.
DWF has a market leading venture and growth capital practice in the UK, supporting investors and companies across several sectors including financial services, technology, media and telecommunications, life sciences and healthcare and real estate and infrastructure. If you have queries on any of the issues covered in this article please contact one of our experts: Dhruv Chhatralia BEM, James Bryce, Caroline Colliston (as the tax representative for the corporate articles), Darren Ormsby, Gemma Gallagher, Gary MacDonald, Paul Pignatelli, Scott Kennedy, Will Munday, Alex Stoughton, Francesca Kinsella, Graham Tait and Rosie Spencer.
Authors: Amrish Sharma, Ceren Ghanem, Jagdeep Lall and Andrea Tarazi.
