Nov 4, 2009
What is "redemption" with respect to preferred stock? What happens if a company can't redeem?
Redemption is a repurchase of shares by a company. Preferred stock terms typically provide for the mandatory redemption of the preferred stock by the company if requested by the investors (investors generally are not permitted to call for redemption until five years after the initial issuance of the preferred stock). The price per share at which the company must redeem the preferred stock is ordinarily equal to the price at which the preferred stock was issued plus a small guaranteed rate of return (e.g., accrued dividends). In practice, redemption rights are not often used; however, they do provide a form of exit for an investor (in the absence of an acquisition or IPO) and some possible leverage for the investors over the company in the future.
Due to absence of funds to repurchase the shares in compliance with statutory restrictions on redemption, it is unlikely that a company will be legally permitted to redeem. Investors will sometimes require that the terms of the preferred stock provide for certain penalties in such a situation. For example, the redemption rights provisions may instead require the redemption amount shall be paid in the form of a one-year note to each unredeemed holder of the preferred stock, and the holders of a majority of the preferred stock may become entitled to elect a majority of the company's board of directors until such amounts are paid in full.
