So, you want REDEMPTION? Really?

Years-maybe decades-ago, I represented venture capital funds in their financings of early stage companies.  I took my charge as a young attorney at a Wall Street firm very seriously, aggressively driving every advantage I could devise to benefit my client.

Sometime later, as general counsel of a company undergoing complex reorganization, the powers of the bankruptcy laws forced me to revamp my views.  That experience, along with several reorganizations later, really drove home a few key principles about structuring corporate deals generally.

Now, for today’s pet peeve, now that I am representing those early stage companies in “angel” investment rounds-

I’ve seen a number of term sheets with provisions which the investors insist protect their investment, but which at best won’t help and may actually hurt the investment.  One of the worst such provisions is a redemption right that can be exercised by any number of the investors, followed by the more traditional redemption right (exercised upon vote of a specified percentage of investors).  There are others, which I will leave for a later post to keep you interested in following the blog.

Particularly with early stage companies, there are two basic possible outcomes: the company will make it to the next “level”, whether next financing, operating results or “exit”, OR the company will “fail,” which would likely result in a reorganization or liquidation under the bankruptcy laws.

Redemption doesn’t help under either outcome. In fact, threatening to drain a company of cash could accelerate the insolvency process (which, under a bankruptcy proceeding would challenge the payment) and, in any case, divert more useful applications of the money.

A recent conversation with several seasoned venture capitalists confirmed this lesson.  One simply capped my statement about harmful investor terms with a single word: “Redemption!”

So, if you really want redemption, . . . redeem yourself  by spending more time due diligencing the business to ensure a successful investment, and less time negotiating terms that won’t help (and could hurt you) anyway.

Thanks for reading the post.  Feel free to respond by telling me redemption serves as an effective “hammer” to pressure the entrepreneur or to add your own pet peeves.

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