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Definition A redemption rights provision in a term sheet requires the company to buy back the investor’s preferred shares at a specified time, upon a specific occurrence, or at the investor’s request.* Typical provisions stipulate that a certain amount of time must pass after the original financing and, if redemption is not mandatory, the holders of a specified percentage of the relevant preferred stock series must vote in favor for redemption to occur. Redemption may take place in a single transaction or installments.* Redemption rights protect investors in the case that a company becomes profitable but not big enough to be an IPO or acquisition candidate.*
danger One version of redemption rights that is particularly dangerous is an “adverse change redemption” clause, which Brad Feld recommends never agreeing to.* This clause gives investors the option to request redemption if there are any significant changes to the company’s prospects. Since it’s usually vaguely worded, this clause gives investors the power to force the company to pay them for their shares in a wide range of scenarios based on arbitrary judgment.
Right of First Refusal and Co-Sale Agreement
The right of first refusal and the co-sale agreement govern how and to whom founders and employees can sell their stock.
Definition A right of first refusal (ROFR) provision in a term sheet gives the company and/or the investor the option to purchase shares from founders or other major common shareholders before they are sold to a third party. If the company or investor exercises this right, the sale must be on the same terms offered by the third party. Some term sheets first give the option to the company, then to the investor,* while others simply give the option to the investor.* If there are multiple venture capital investors, the ROFR provision typically specifies that each has the option to purchase a pro rata portion of the shares being sold.*
Definition A co-sale agreement (co-sale rights or tag-along provision) in a term sheet gives one group of stockholders the right to sell their shares when another group does so, and under the same conditions. In venture capital deals, these clauses are typically used to ensure that investors will be able to participate on a pro rata basis in any sales made by founders or other stockholders who pass a specified ownership percentage threshold.
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