You’re reading an excerpt of The Holloway Guide to Raising Venture Capital, a book by Andy Sparks and over 55 other contributors. A current and comprehensive resource for entrepreneurs, with technical detail, practical knowledge, real-world scenarios, and pitfalls to avoid. Purchase the book to support the author and the ad-free Holloway reading experience. You get instant digital access, over 770 links and references, commentary and future updates, and a high-quality PDF download.

Term sheets may specify various restrictions on sales (ROS or transfer restrictions). Types of restrictions include: preventing stockholders from selling within a certain time period or until a certain valuation has been reached; subjecting sales of stock to consent by the board of directors and/or other stockholders; giving some stockholders right of first refusal on the sale of others’ stock; incorporating a co-sale agreement; and simply prohibiting the sale of stock altogether. These restrictions may appear in a clause titled Restrictions on Sales or under other headings.

Redemption Rights

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.

If you found this post worthwhile, please share!