Term Sheet (6) Redemption |When can VC divest from startups?

Venture Capital Terms and Conditions in a Nutshell for Founders to Read and Understand Term Sheet on Their Own ~ I'm U.S. lawyer Xiaoxiao Liu.

There are five general exit channels for VCs:

(1) Initial Public Offering (IPO)

(2) Mergers and acquisitions (acquisition)

(3) Share transfer (trade sale)

(4) Liquidation of a company

(5) share repurchase (redemption)

The first type of IPO is of course a happy situation, VCs can sell their shares in the open market to realize the capital cash, but the IPO of the company is, after all, rare, and most of the companies in fact are still through the middle three ways to exit, mergers and acquisitions, share transfers and liquidation of the company are counted as a liquidation event (Liquidation Event), these cases VCs through liquidation In these cases, VCs exit through liquidation preference with an agreed-upon return multiple.

However, in addition to the above cases, if the company is not doing well, how can the VC realize the exit, which requires a share repurchase (Redemption) clause?

1. Redemption

The following are common examples of Redemption clauses in Term Sheet Venture Capital terms.

Redemption: At the election of the holders of at least the majority of the Series A Preferred Shares, the Company shall redeem the outstanding Series A At the election of the holders of the at least the majority of the Series A Preferred Shares, the Company shall redeem the outstanding Series A Preferred Shares in three annual installments beginning on the fifth anniversary of the Closing. Such redemption shall be at a purchase price equal to the Original Purchase Price plus declared and unpaid dividends.

Repurchase: If a majority of the Class A Preferred Stockholders agree, the Company shall repurchase the outstanding Class A Preferred Stock in three annual installments beginning on the fifth anniversary of the Closing. Such redemption shall be at a purchase price equal to the Original Purchase Price plus declared and unpaid dividends.

Although share repurchase rights are an important provision in VC investment agreements, they are almost never, if ever, enforced in practice. However, share repurchase rights exist for a number of reasons.

a. What worries VCs the most is not that the startup has burned out, but that it is half-dead, that is, in a state of "Walking Dead". The company is able to generate a certain amount of revenue to maintain its operations, but is unable to grow to the point where other companies are interested in acquiring it or meeting the criteria for going public. In this case, if the VC has the right to buy back the shares, then there is an imperial sword, can be taken out at this time, who stops me from quitting I'll cut who, God blocking the God, Buddha blocking the Buddha, anyway, I have to quit.

b. Venture capital funds have a life cycle, usually 10 + 2, this 2 basically can not be used, so it is about 10 years. Usually in the first 1-4 years to invest out, after the investment of 5-7 years or so to realize, so as to recover the funds within 10 years, otherwise the fund manager and their LPs have no way to explain.

For example, the whole capital to invest in AI, assuming that Yang Kang did not appear behind those moth things, but there has been no progress. Yang Kang made out of the software called "Wanyan intelligent simultaneous small secretary", can seamlessly connect the Jin's Jurchen language and the Chinese language of the Song Dynasty, at first also accumulated a lot of loyal users, basically can reach break even. But after all, this is a niche market (Niche Market), and we all know that with the progress of internationalization, the Chinese of the female real people is serious, this project can not have a greater development, and it is not a good thing to keep mixing like this. Even if the Qiu support, but the whole capital is seven GP joint decision-making system, now four of the seven GP inside have been very disapproving of the finish AI, especially GP Wang Chuyi said, we are now investing in the finish AI has been so many years, LP are still waiting to share the money, can not be so delayed, so in the whole capital of the whole capital of the seven GP decision-making, or to activate the right of repurchase, the whole capital with the original investment price plus 8% annualized. The original investment price plus 8% annualized dividend from the AI.

2. Material Adverse Change Redemption

In addition to the common type of share repurchase right (Redemption), there is another type of Material Adverse Change Redemption (Material Adverse Change Redemption), a common example of which is as follows:

Adverse Change Redemption: Should the Company experience a material adverse change to its prospects, business or financial position, the holders of at least majority of the Series A Preferred shall have the option to commit the Company to immediately redeem the outstanding Series A Preferred. Such redemption shall be at a purchase price equal to the Original Purchase Price plus declared and unpaid dividends.

Yang Kang, the founder of Finish AI, actually triggered the material adverse change clause and allowed All Real Capital to decide to exercise the repurchase right. What are all the material adverse changes?

a. Moral scandal brought about by family ethical relationship. After finding Yang Tiexin, the people learned that the person who almost killed Yang Tiexin was not Duan Tiande, but Wanyan Honglie, so they persuaded Yang Kang to sever his ties with the Great Jin Empire and return to the Han people. However, Yang Kang agreed to do so on the surface, but he couldn't let go of his honor and wealth and returned to being a young prince again, recognizing the thief as his father.

b. Sexual scandal brought about by the abandonment of his girlfriend. Yang Kang won the martial arts competition and then refused to marry Mu Nianci, which was already a mistake in the first place. Mu Nianci to Yang Kang has been secretly promised, you say this time Yang Kang if really not interested in Mu Nianci words you say, but he did not reject Mu Nianci, but a hanging Mu Nianci, was paparazzi many times secretly photographed Yang Kang and Mu Nianci intimate behavior.

Just these two things, so that Yang Kang's public image has been greatly damaged, Finish AI is facing a huge public relations crisis, the whole truth capital such a first-line fund are powerless to return to heaven. Under such circumstances, the GP of Quanzhen, Qiu Qiqi, activated the Material Adverse Change Redemption (MACR) and divested from Finish AI.

3 Scope of Application of Repurchase Right

First of all, it should be noted that the Redemption clause is a relatively common clause in China's venture capital, and it can be said that more than half of the investments have this clause, but for the U.S. venture capital it is very uncommon, and it can be said that at least purely U.S. venture capital investment will not have this clause at all. Because the U.S. capital market is still relatively mature, the investment would have been willing to gamble, don't whole this kind of possibility of withdrawal of capital terms. After all, China's private equity investment has only been developed for two or three decades, and there are still many places that are not completely "venture capital".

In fact, the repurchase right is also a problem in accounting, because this kind of preferred shares (Redeemable Preferred Share, RPS) with repurchase right is more similar to the enterprise's liabilities, rather than investment.

Therefore, the most important thing to do is not to accept a redemption clause. If you really have to accept it, then you should also pay attention to try to drag the investor can start to exercise the exercise of the right of repurchase time (for example, more than 5 years are more reasonable, if 3 years, 4 years or something that is too tight). Another is that investors can be proposed to buy back in installments, so that the cash flow pressure on the startup company is also relatively small. Finally, the buyback price, the better is the original investment price, or add a dividend, the worse is to be, for example, double or so in accordance with the multiple of the buyback price.

Here is the venture capital terms and conditions of the essence, so that founders read Term Sheet ~ I am the U.S. lawyer Liu Xiaoxiao, we will see you in the next issue.