The redemption amount, the instalment schedule, the investor's real IRR and whether the company can actually pay, worked on one illustrative minority deal.
A redemption right lets the investor require the company to buy its preferred shares back for cash after a fixed date, usually at cost plus a coupon. On a 60.0 growth investment redeemable after five years at 8 per cent compounding, the claim is 88.16. Paid, as is common, in three annual instalments without interest, the investor earns 6.65 per cent, not 8.00, and a company with 18.0 of EBITDA can raise only 53.0 towards it.
Worked in full in The Growth Equity Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Minority growth investors have no control over the exit. The redemption right is their substitute: if the company has not been sold or listed by the agreed date, the investor can turn its equity into a debt-like claim on the company. In practice it is almost never exercised to the end. Its value is the conversation it forces at the board, and that conversation depends on three numbers: how much is owed, when it is paid, and whether the company can pay it.
| Term | Value |
|---|---|
| Investment, preferred shares | 60.0 |
| Redemption exercisable from | end of year 5 |
| Redemption price | cost plus 8% compounding |
| Payment | 3 equal annual instalments |
| Company EBITDA at year 5 | 18.0 |
| Debt drawn at year 5 | 20.0 |
| Maximum total debt lenders will accept | 3.5x EBITDA |
| Cash available beyond operating needs | 10.0 |
=Invest*(1+Rate)^5.=IRR(range) over the eight annual cash flows, or =XIRR with dates.The headline coupon is 8 per cent; the instalment schedule takes 1.35 points of it away, because two thirds of the money arrives one and two years late without interest. If the documents say unpaid instalments accrue at the same 8 per cent, the payments become 29.39, 31.74 and 34.28, 95.40 in total, and the IRR is restored to 8.00 per cent. That one sentence in the articles is worth 7.24 of cash to the investor.
The company's side is less comfortable. A lump-sum redemption of 88.16 is 4.90 times EBITDA. Against 53.0 of capacity the shortfall is 35.16, and paying it from the surplus cash plus new debt would take total debt to 5.45x EBITDA. The first instalment of 29.39 is affordable with 23.61 to spare; the second and third depend on the next two years' cash generation.
Most jurisdictions allow redemption only out of lawfully available funds. A redemption right the company cannot fund is a claim that waits, and waiting is expensive: 88.16 received in one sum at year 7 instead of year 5 is a 5.65 per cent IRR, and at year 9, 4.37 per cent.
| Coupon | Redemption amount | Instalment | IRR, lump sum | IRR, instalments | Shortfall vs capacity |
|---|---|---|---|---|---|
| 0% | 60.00 | 20.00 | 0.00% | 0.00% | 7.00 |
| 6% | 80.29 | 26.76 | 6.00% | 4.99% | 27.29 |
| 8% | 88.16 | 29.39 | 8.00% | 6.65% | 35.16 |
| 10% | 96.63 | 32.21 | 10.00% | 8.30% | 43.63 |
Even a plain 1x redemption is 7.00 beyond this company's means in a single payment. A higher coupon makes the right more valuable on paper and less collectable in practice, because every point is added to a claim the company already cannot meet at once.
A growth investor underwriting 3.0x in five years is underwriting a 24.57 per cent IRR, 180.0 back on 60.0. The redemption right promises at best 8.00 per cent, delivered late and in pieces by a company that has, by definition, failed to reach an exit. It is not a floor on the investment case; it is a floor on how badly a stalled position can be ignored.
That is why its real price is negotiated in the surrounding terms: interest on late instalments, the step-up rights if the company cannot pay, and whether the redemption amount is cost plus a coupon or the higher of that and fair value. The same 8 per cent accrual, taken as a liquidation preference instead of a cash claim, is worked in how an accruing dividend changes a growth equity return. Compared side by side, the preference pays only at an exit and the redemption right forces one.
The arithmetic of holding a minority growth position through later rounds, including what defending the stake costs, is worked in the free companion workbook.
After a date fixed in the articles, typically five to seven years from closing, and usually only if no exit has happened. On an illustrative 60.0 investment redeemable from year 5 at cost plus 8 per cent compounding, the claim is 88.16. The right is rarely exercised; its value is the pressure it puts on the board to find an exit.
It pays what it lawfully can and the rest stays owed, often with step-up rights for the investor such as extra board seats. If an 88.16 claim is finally paid in one sum at year 7 with no further accrual, the investor's IRR falls from 8.00 to 5.65 per cent; at year 9, to 4.37 per cent.
Economically close: both force a cash buy-back at a pre-agreed price. A redemption right is a term of the shares, payable by the company from distributable funds; a put is usually a contract that may sit against founders or other shareholders. Either way the price is typically cost plus a coupon, 88.16 on 60.0 at 8 per cent for five years.
This article is one calculation from The Growth Equity Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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