How Does a Company Redeem Redeemable Shares in England?

As a shareholder or director in a company, you may receive redeemable shares as a condition of providing the company with cash. Before exercising your redemption rights in those shares, there are legal processes to note. This article will explain how a company can redeem shares and important practical considerations for shareholders and directors. 

What are Redeemable Shares?

Redeemable shares stand in contrast to ordinary shares, which entitle the holder to keep the shares until they choose to sell them (or the company is wound up or sold). Redeemable shares effectively give the redeemable shareholder status as a shareholder for a temporary period. 

The terms attached to the redeemable shares will specify an event, like an IPO or a fixed date, which gives the shareholder or company (or both) the right to exercise the option to redeem the shares. Notably, this is a right to redeem, not an obligation. If the shareholder chooses to redeem their shares, the company effectively buys the shares from the shareholder. 

Other key terms include the price at which the shares will be redeemed and which party has the power to redeem the shares. These terms will be specified by either:

• the company’s articles of association; or 
• at the discretion of the directors under certain circumstances. 

Finally, a company has to issue redeemable shares as redeemable shares. That is, the rules that govern the redemption of redeemable shares do not apply to shares issued as ordinary shares or other kinds of shares like preference shares. 

An Example 

Suppose a company issues 100,000 redeemable shares to four early-stage seed investors, including your own company. In exchange, each investor pays the company £25,000 in cash. 

Your company and the other investors agree to the following terms, which are set out in the company’s articles:

• after five years or the date the company successfully, whichever comes first, the shares can be redeemed; 
• both the company and the redeemable shareholders have the right to exercise the redemption option; 
• the redemption option is not mandatory; 
• the shares will be redeemed at a value of £1.60 per £1 share held; 
• the shares must be redeemed within 30 days from the date the option to redeem arises; and 
• until the redemption option is exercised, the shares have the same rights as those attached to the ordinary shares. 

Three years later, the company raises £500,000 in Series A funding, entitling both you and the company to exercise the redemption options. You decide to exercise the option and transfer the shares to the company. In exchange, the company pays you £40,000 in cash. 

Process of Redemption 

The law permits a company to redeem existing redemption shares through two different means. A company can pay for the redemption:

1. out of its profits or the proceeds of a new share allotment; or 
2. from the company’s existing share capital. 

Each method has its own rules regarding when a company can lawfully redeem redemption shares. 

Profits or New Share Allotment

Before a private company can redeem its shares, they must satisfy the following conditions:

• the company’s articles do not restrict their ability to issue shares; 
• the company has a separate class of non-redeemable shares; 
• the shareholders have paid the company the full value of the shares at the point they were issued before the company redeems them; 
• either the company sets out the rights attached to the redeemable shares in the company’s articles; or
  • has a term in its articles that grants the directors power to determine the rights attached to the shares; or 
  • the shareholders authorise a resolution granting the directors power to determine the rights attached to the shares. 
• upon redemption, the shares are treated as cancelled and not transferred to a third party; and 
• the directors notify Companies House within one month from the date the shares are redeemed, along with a statement of capital.

Share Capital 

The law is more restrictive in the ability of a company to redeem shares out of its capital. Share capital refers to the value of the shareholders’ investment in the company. 

Before a company can redeem shares, the following conditions must be fulfilled:

• the company’s articles must not restrict the company from redeeming shares from its capital;
• if there are any distributable profits or money raised from a share allotment, these funds must be used before the company’s share capital; 
• the accounts used to determine the amount of distributable profits must not have been prepared more than three months from the date that the directors make a written statement attesting to the company’s solvency. 

If your company fulfils the above conditions, the directors must prepare certain documents before the shares can be redeemed, including:

• a statement of solvency, which is where the directors attest to the fact that the company can pay its debts for the next 12 months; 
• an auditors report, which an independent auditor prepares; and 
• a shareholder resolution passed by a special resolution within a week after the directors sign the statement of solvency. 

Your company’s shareholders and directors must undertake additional steps before the shares can be redeemed with the company’s share capital. There is a short window between when you must complete certain steps, which is why you will almost certainly need to instruct a legal team in addition to your accountants. 

Key Takeaways 

Redeemable shares grant the shareholders temporary rights of membership in the company. The redeemable shares grant the company or the shareholder the right to choose to trade the shares back to the company in exchange for cash, usually paid at a premium to the amount initially paid by the shareholder. This option arises after some event passes, such as a date or a subsequent equity issue. There are two ways to redeem shares, either through: 

• using the profits raised from a subsequent share allotment, or 
• using the company’s share capital to redeem the shares. 

Each method has its own rules. Redeeming shares through profits or the proceeds of a share issuance is typically much easier than using a company’s share capital. 

If you need help with your business, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

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