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Companies can issue different classes of shares that have different rights attaching to them. The class of shares a company may issue will depend on the interests of the shareholder and the company at the time. It may be that your investors request redeemable preference shares as a condition of their investment. Most likely, this is because they wish to protect their interests by holding a class of shares which are:

  • redeemable; and
  • have preferential rights.

This article explains:

  • what it means to have shares with redemption rights;
  • what it means to have shares with preferential rights, and
  • the reason why your company might issue redeemable preference shares.

Power to Issue Different Types of Shares

The general position under the Companies Act 1993 (NZ) is that a company may issue different classes of shares. For example, companies may issue shares which are:

  • redeemable;
  • confer preferential rights to distributions of capital or income;
  • confer special, limited or conditional voting rights; or
  • do not confer voting rights.

In addition to this general position, a company may also adopt a company constitution. The constitution will further elaborate on (or limit) a company’s right to issue different classes of shares.

What Are Redeemable Shares?

Redeemable shares are those that allow the company issuing shares to repurchase the shares in the future. You make this agreement upfront, in exchange for payment by the company to the shareholder for those shares.

To issue redeemable shares, the company’s constitution must allow the company to issue preference shares. The company’s constitution should also specify the terms of those redeemable shares, by setting out that the shares are redeemable either:

  • at the option of the company;
  • at the option of the shareholder; or 
  • on a specific date or based on certain terms, for example, based on a particular event happening.

The terms should also specify the amount which the company needs to pay the shareholder to redeem their shares. The constitution can either: 

  • set out the specific share price payable; 
  • contain the formula to calculate the share price; or 
  • state that a suitably qualified third party will determine the price at the time of redemption.

What Are Preference Shares?

Preference shares refer to shares which have preferential rights to distributions by the company of capital or income, in priority to distributions to holders of ordinary shares.

For startups, it is unlikely that they will be distributing dividends for the first few years (if ever). This is because they will likely reinvest any profit to achieve greater company growth. The focus will be growing the company so that it is in a position to secure an exit event, such as an IPO or a trade sale.

For this reason, the types of preference shares which startups typically issue to investors are shares which have a preferential right to receive proceeds in the case of a liquidation event. This right is commonly referred to as a ‘liquidation preference.’

The specific terms of the liquidation preference, which are conferred by a class of preference share, will need to be agreed with the investor and set out in the company’s constitution. Typically, a liquidation preference allows the investor, in the case of a liquidation event, to receive back the amount they paid on their shares in preference to payments to all other shareholders.

This protects the investor by assuring them that if there is a liquidation event (whether an exit by the company or a winding up of the company), that they will get their money back before payments to other shareholders.

Why Issue Redeemable Preference Shares?

A company may issue different classes of shares, each with varying rights. A redeemable preference share is a type of share which may be issued by a company. This class of share has the ability to both: 

  • be redeemed; and
  • have preferential rights to distributions of capital or income.

A key component of negotiating with investors is determining what rights will attach to their shares. You may end up agreeing with investors to issue them with redeemable preference shares.

Investors may push to be issued redeemable preference shares by your company because it can be very advantageous to them. This class of shares ensure that investors can redeem their shares and get their money back (and potentially with an accrued amount in addition to this, similar to how a loan may accrue interest) if certain conditions are not met.

For example, the company might not perform as expected. Likewise, if an exit event occurs, or the founders choose to wind up the company, investors will receive their money back in preference to the distribution of money and assets to holders of ordinary shares.

Conversely, issuing redeemable preference shares can be risky for the company and the founders. Investors may unexpectedly exercise the option to redeem their shares. In that case, the company must be sure that it will have enough funds to pay back the investors. Founders will also want to ensure that the value of the company will grow enough, to undertake obligations in the case of a liquidation event. After the company pays proceeds to any creditors and preference shareholders, there is pressure to ensure that sufficient funds remain to issue to other ordinary shareholders.

Key Takeaways

If you are negotiating with an investor, it is essential to understand the rights which will attach to the shares the company is issuing. This is especially the case with redeemable preference shares, which often have terms that are advantageous to the investor holding those shares and risky for the company, founders and other shareholders. If you require assistance with issuing shares or raising capital, contact LegalVision’s New Zealand startup lawyers on 0800 005 570 or fill out the form on this page.

FAQs

What are redeemable shares?

A company which issues redeemable shares has the right to repurchase those shares in the future, in exchange for payment.

How can I issue redeemable shares?

Your company can issue redeemable shares if it is permitted by your constitution, which should also specify the terms on which to issue those shares.

What Are Preference Shares?

Preference shares refer to shares which have preferential rights to distributions by the company of capital or income, in priority to distributions to holders of ordinary shares.

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