Leaving quietly: the redemption of shares as an exit event

When we talk about equity investments, one of the subjects that has been keeping the investors and managers up at night is the exit strategy.

And with reason. When successful, the exit strategies ensure investors, managers and other stakeholders, the earnings from years of strategy work and resources allocation, directly influencing the success of the investment.

When the investment meets the expectations, it is common for investors to exit through an equity sale to another player in the market or even through an IPO, achieving good returns to their investments.

The question remains: what if the invested companies do not met expectations and/or there are difficulties in executing exit strategies like the above? For some investors, it is a risk worth taking and the premium received for some investments compensate the lack of liquidity of others. For others, especially those in search for returns closer to a fixed income and less interested in big exit premiums, the lack of liquidity may be a big problem. To these investors, in a market with no liquidity, the redemption of shares may be a good alternative.

The redemption of shares is nothing more than the payment, by the invested company itself, of the value of its shares held by one or more shareholders to permanently cancel them, using for payment part of the company’s results or its capital reserve.

However, for the redemption of shares to be a quick and efficient exit strategy, it needs to be thoroughly studied by the investor. We can highlight some precautions that must be taken from the beginning of the investment, such as the setup of a specific class of shares, the formation of capital reserve in the contributions made throughout the investment period, the rules to calculate the redemption price – which can take many forms such as discounted cash flow and book value – and the procedures for implementing the redemption.

It is important to note that since the redemption of shares depends on the invested company’s cash and accounting results, it may be that the situation of the company does not allow the redemption to be made at the time the investor intends to leave the company. In addition, as a rule, redemption is a company’s option and not an obligation. When the company is contractually bound by the redemption, it becomes an obligation and, most likely, a liability on its financial statements.

Therefore, the redemption is an exit possibility, but contains uncertainties. Thus, it is important to verify the structure of each transaction to assess the viability of this alternative and tax aspects for the company and the investor.

By Raphael Pereira Arantes Pires, associate at Candido Martins Advogados