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What Are Redeemable Shares
Redeemable shares refer to a type of stock in a corporation’s share capital that can be redeemed by the corporation.
Corporations can have different types of shares in their share capital such as common stocks and preferred stock.
Common stocks or ordinary shares are not redeemable.
However, other classes of stock such as preferred shares can be either redeemable or not depending on the rights associated with the stock class.
Corporations can only redeem classes of stock that are redeemable.
The corporation can purchase classes of stock that are not redeemable or complete a share capital reduction.
Typically, corporations must have at least one class of non-redeemable stock along with other classes of stock that could be redeemable.
In other words, a corporation cannot only have redeemable shares issued to all its shareholders.
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Why Issue Redeemable Shares
There are two primary reasons why corporations may issue redeemable shares: to provide an investor with an exit strategy or to be able to buy out certain shareholders.
If the redeemable shares are issued as a means to provide an investor with an exit strategy, the corporation is looking to provide some assurance or comfort to the investor to invest.
For example, an investor may not be willing to invest a lot of money unless he or she can have some of that money returned after a certain number of years.
As a result, the corporation may choose to issue common shares and redeemable shares to the investor for the investment.
The common shares will have the regular voting rights and privileges that shareholders typically have.
However, the corporation agrees to pay dividends on the redeemable shares for five years and then redeem them at a determined price.
This way, the investor knows that he or she is limiting somewhat the investment risk.
The second reason why redeemable shares are issued is to specifically buy out certain shareholders.
In this case, the corporation’s objective is to remove certain shareholders.
For instance, a corporation could have issued convertible redeemable shares to certain employees allowing the employees to convert the shares to common stock after five years.
If the corporation does not want the employees to convert their shares into common stock, before the conversion rights come into force, it can redeem the shares.
This way, the employees will no longer be able to convert their shares into common stocks.
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Types of Redeemable Shares
There are generally two types of redeemable shares: maturity date shares and call date shares.
Maturity date shares are redeemable shares where the corporation is required or obligated to redeem the shares after a certain date.
When the maturity date arrives, the corporation is required to pay the shareholder and redeem the shares.
The shareholder will receive cash consideration and will no longer own the shares.
The call date shares are redeemable shares giving the corporation the right to redeem them without forcing the redemption.
In other words, the corporation can choose to redeem the shares if it elects to do so.
Depending on the investor purchasing the shares, the corporation may choose to offer a maturity date redeemable shares or call date redeemable shares.
Investors looking to put a lot of money in the corporation may prefer to acquire maturity date shares whereas the corporation may choose to issue call date shares to key employees.
If the employees leave the company, the corporation redeems their shares.
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How Redeemable Shares Work
Redeemable shares represent a type of shares that the corporation can buy back from its holder at a specific point in time in the future.
For the shares to be redeemable, the company’s chart must allow for the creation of such a class of stock and the issuing documents should outline the specific redemption rights.
Very often, redeemable shares are considered to be preferred shares as they grant the holder certain rights and privileges over other classes of stock.
However, redeemable shares are not necessarily preferred shares all the time.
Holders of preferred shares where they are entitled to dividends or have other special voting privileges may have redemption terms associated with their class of stock.
This way, the corporation can exercise its redemption rights and buy back the shares.
The corporation can decide as to the redemption date which can be specifically set, left to the board of directors to establish, or can be left for the company shareholders to set.
As for the share redemption price, the amount can either be fixed or calculated based on a predetermined formula.
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Share Redemption Considerations
Corporations looking to redeem shares must consider the circumstances to ensure they are making the right decision.
The most important thing to consider is the corporation’s ability to finance the redemption.
If the corporation does not have enough distributable profits or assets to be able to redeem the shares, then the redemption can put a financial strain on the company.
Also, when corporations redeem shares, they must ensure they comply with the corporate laws, company charter, and any shareholder agreement that may be in place.
Once the corporation has validated that it has the necessary finances to complete the redemption and complies with any applicable statutory requirements, it will then need to redeem the shares as per the redemption terms.
In some cases, if the redemption is performed exactly as per the issuing document requirements, the corporation may not need to get any special approvals.
However, if the redemption requires the board’s approval or shareholder approval, then a special resolution must be adopted authorizing the redemption.
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Redeemable Shares vs Convertible Shares
What is the difference between redeemable shares and convertible shares?
Redeemable shares represent a category of stock that can be “bought back” by the corporation at a predetermined price or at a predetermined date.
Redeemable shares can either obligate the corporation to redeem the shares at a certain date or give the company the option to redeem the shares.
On the other hand, convertible shares are a type of stock that can be exchanged into common shares.
For instance, a convertible preferred stock allows the holder of the shares the right to convert the shares into common stocks.
Investors who are looking to reduce risk but have the ability to profit from a corporation’s potential upside in stock price appreciation may prefer to have preferred convertible stocks guaranteeing his or her dividends but have the right to convert the stock to common shares.
This way, the investor will effectively trade the guaranteed dividend for the potential upside in the appreciation of the corporation’s common stock.
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Takeaways
So there you have it folks!
What are redeemable shares?
In a nutshell, redeemable shares are shares of stock that the corporation can repurchase at a certain time in the future.
In other words, the redeemable shares can be bought back by the corporation at some point in the future in exchange for cash.
There are several advantages to issuing redeemable shares as the corporation can buy back the shares, it allows the corporation to increase its earnings per share (EPS), and provide greater value to its shareholders.
On the other hand, redeemable shares can only be redeemed at the time outlined in the issuing documents and it can only be advantageous for the corporation if the redemption price is below the market price.
Now that you know what redeemable shares are all about and how they work, good luck with your research!
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