Why should you be careful about the redemption rights in your term sheet?

In this blog post, we dive into the significance of redemption rights with an expert explaining why start-up founders should be cautious about them in their term sheets. Peter Pašek, co-founder of AceON Accelerator, shares his insights on this topic.

Among the conditions in the term sheet, which are not often discussed (but should be) are the so-called redemption rights. There are several options for modifying the right of redemption, depending on the legal form of the start-up or the legislation of the country in which the start-up is established.

In practice, this represents an opportunity for the investor, usually at a pre-agreed price, to sell their investment back either to the start-up (note: some legal forms or legislations do not allow this option) or to the founders or other investors. 

Founders often overlook the fact that investors include this clause in term sheets, especially if they invest in the start-up in the late phase of their investment period (the fund is typically created for a 10-year term with the possibility of extension for a few more years) for which the fund was created. When the fund is liquidated and pays out potential rewards to its limited partners, it will have the opportunity to potentially receive cash from start-ups that are not yet far enough for an exit to be considered.

Founders are often unaware of the commitments they make under this clause. For example, 5 years after the investor's entry, they may have to deal with financing and figure out how to- buy the investor out of the relationship if the investor exercises their right. Peter Pašek concludes:

I don't claim that these provisions have no justification in term sheets, and I understand their application by investors. I just want to emphasize that founders often overlook the possible risks that may arise from accepting these provisions. So, be cautious.

March 11, 2024

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