Building a startup is a marathon, but investors may not run the full distance with you. When a condition in the investment agreement is triggered, an investor may suddenly pull out that agreement you signed casually and demand that you repurchase their equity at the agreed price. This “buy-back” right is the redemption right.
To investors, the redemption right is a “safe exit channel”; to founders, it can be a bolt from the blue — because you may simply not have that much money.
Today, Lawyer Kevin Jun Lin will provide an in-depth analysis of the redemption right clause, helping you understand its trigger conditions, price calculation and legal consequences, so that you can see the true nature of this “post-dated check” before you sign.
I. Case Introduction: A Chain of Crises Triggered by a Redemption Clause
Typical case: In 2018, a founder surnamed Wang of a certain biomedical company completed its Series B financing, securing a total of RMB 150 million from several well-known institutions. The investment agreement provided that if the company failed to complete its A-share IPO by December 31, 2022, the investors would be entitled to require the founder to repurchase all of the equity they held at “investment principal plus 12% annual compound interest.”
In 2022, affected by changes in industry regulatory policies, the company’s IPO process was delayed. In early 2023, the lead Series B institution first sent a redemption notice to the founder, demanding payment of approximately RMB 210 million in redemption proceeds. The founder was unable to pay and tried to negotiate an extension with the investors, but the request was refused.
What was even more unexpected was that the investment agreement contained a cross-default clause: the exercise of the redemption right by any one investor would automatically grant the same right to all other investors. As a result, five investment institutions from both Series A and Series B demanded redemption simultaneously, with the total amount exceeding RMB 350 million.
Founder Wang not only had his personal properties seized, but also, having been listed as a judgment debtor subject to enforcement, was subjected to high-consumption restrictions and barred from taking high-speed trains or flights. The company also fell into operational distress due to the founder’s debt crisis; its core team resigned one after another, and it eventually went into bankruptcy liquidation.
This case reveals a harsh truth: the redemption right clause usually “hides” in a corner of the investment agreement, but once triggered, it can become the last straw that breaks the founder and the company.
II. What Is the Redemption Right Clause
(1) Definition
The redemption right (Redemption Right), also known as the repurchase right, refers to the right of an investor to require the company or the founder to repurchase the company equity held by the investor at the agreed price and in the agreed manner when the stipulated conditions are satisfied.
The redemption right is essentially an “exit mechanism.” The ultimate purpose of an investor’s investment in a company is to exit profitably, yet exit channels such as IPO and M&A are highly uncertain. The redemption right provides investors with a “capital-protected exit” channel — even if the company cannot go public or be sold, the investor can require the founder or the company to buy back the equity, thereby securing the safety of principal and a minimum return.
(2) Legal Nature of the Redemption Right
The legal nature of the redemption right clause is subject to some controversy in both academic and practice circles, and the main views are as follows:
- Conditional contract theory: The redemption right clause is a conditional equity transfer contract; when the triggering condition is satisfied, the investor is entitled to require the founder to perform the repurchase obligation.
- Option theory: The redemption right is a put option held by the investor, who may exercise the right to sell the equity under the agreed conditions.
- Security theory: The redemption right is a security mechanism established by the investor to safeguard investment safety, and is accessory in nature.
In judicial practice, courts generally characterize the redemption right clause as a special agreement between the parties, falling within the scope of autonomy of will. As long as it does not violate the mandatory provisions of laws and administrative regulations, its validity is generally recognized. Article 5 of the Nine Civil Minutes (Minutes of the National Courts’ Meeting on the Trial of Company Law Cases) expressly provides for this.
According to the adjudication rules of the Nine Civil Minutes:
- Investor vs. founder VAM: The agreement is valid and may be enforced in practice. The founder must bear the repurchase obligation.
- Investor vs. company VAM: The agreement is valid in principle, but its performance is subject to the company’s capital reduction procedure. If the company has not completed the capital reduction, the court will dismiss the investor’s claim requiring the company to repurchase.
This is also why investors generally require the founder personally to bear the repurchase obligation in practice — a company repurchase faces the enforcement obstacle of the capital reduction procedure, whereas a personal repurchase by the founder can be directly enforced.
III. Trigger Conditions of the Redemption Right
The trigger condition of the redemption right is a core clause in the investment agreement, directly determining when the investor can “knock on the door for payment.” Common trigger conditions include the following categories:
(1) Failure to Meet Performance Targets
Investment agreements typically provide that the target company must achieve certain financial indicators (such as net profit, operating revenue, etc.) in specific years. If the company fails to reach 70%–80% of the committed performance for two consecutive years, the investor is entitled to request redemption.
Sample clause: “If the audited net profit of the company for any of the fiscal years 2024 and 2025 is lower than 75% of the committed net profit, the investor shall have the right to require the founder to repurchase all or part of the company’s equity held by the investor.”
(2) Failure to List on Schedule
This is one of the most common redemption triggers. Investment agreements typically provide that the company must complete a qualified listing (IPO) by a certain date, failing which the investor is entitled to request redemption.
Sample clause: “If the company fails to complete its initial public offering and listing on a securities exchange in mainland China (including but not limited to the Shanghai Stock Exchange, the Shenzhen Stock Exchange, and the Beijing Stock Exchange) before December 31, 2026, the investor shall have the right to exercise the redemption right.”
Risk warning: The redemption risk of an IPO-based VAM is extremely high, because whether a company can list depends not only on its own performance but also on various uncontrollable factors such as the capital market environment, industry regulatory policies, and the pace of review. In recent years, A-share IPO review has tightened, and a large number of companies have triggered redemption for failing to meet their IPO VAM targets. When founders sign such clauses, they must leave ample buffer room.
(3) Material Breach by the Founder
Investment agreements typically enumerate a series of representations and warranties by the founder or the company; a breach of these commitments constitutes a “material breach” that triggers the redemption right. Common material breach scenarios include:
- The founder leaves office or engages in a competing business within the agreed period;
- The company’s core intellectual property has defects in ownership or risks of infringement;
- The company provides external guarantees, disposes of material assets, or makes external investments exceeding a certain amount without the investor’s consent;
- The company’s financial statements contain material misrepresentations or material omissions;
- The company’s principal business undergoes a substantial change.
(4) Other Trigger Conditions
In addition to the main triggers above, the investment agreement may also stipulate the following redemption trigger events:
- Change of control: The actual controller of the company changes, or the founder loses control of the company.
- Liquidation event: The company enters liquidation or bankruptcy proceedings, or has its business license revoked.
- Departure of key personnel: A agreed proportion (e.g., over 50%) of core technical personnel or the management team leaves.
- Failure of a qualified financing: The company fails to complete the next round of financing within the agreed period.
IV. Calculation of the Redemption Price
The calculation method of the redemption price is one of the clauses founders should pay the most attention to, because it directly determines the amount payable when redemption is triggered. Common methods for calculating the redemption price include the following:
(1) Principal Plus Fixed Return
The most common redemption price calculation method is investment principal plus a fixed return, namely:
Redemption Price = Investment Principal × (1 + Annualized Return Rate × Investment Term)
Among these, the negotiated range for the annualized return rate is typically between 8% and 15%. The calculation may be on a simple-interest or compound-interest basis, and the investment term may be calculated by actual days or rounded to whole years.
Example: An investor invests RMB 10 million at an annualized return rate of 12% for 3 years; on a simple-interest basis the redemption price is RMB 13.6 million, while on a compound-interest basis it is approximately RMB 14.05 million. The difference between simple and compound interest grows significantly over long-term investments.
(2) Principal Plus Dividends / Interest
Some agreements provide that, in addition to the principal and fixed return, the redemption price shall also include dividends or interest declared but unpaid during the investment period.
Redemption Price = Investment Principal × (1 + Annualized Return Rate × Investment Term) + Declared but Unpaid Dividends
(3) Fair Market Value
A few agreements provide that the redemption price be calculated based on the fair market value of the company’s equity at the time the redemption is triggered. This method is relatively favorable to the founder, because the redemption price decreases accordingly in a down round. However, the determination of “fair market value” is often disputed and may give rise to new disputes.
(4) A Fixed Multiple of the Investment Principal
Some early-stage investment agreements provide that the redemption price is a fixed multiple of the investment principal (e.g., 1.5x or 2x). This method is simple to calculate but may be unfair to the founder — if the company appreciates rapidly after the investment, the investor’s repurchase at a fixed multiple instead gains excess protection.
(5) Key Points in Negotiating the Redemption Price
Founders should focus on the following points in negotiations:
- Seek simple rather than compound interest: The cumulative effect of compound interest over the long term is startling, so founders should firmly seek simple-interest calculation.
- Set a cap on the redemption price: To avoid unlimited accumulation of the redemption price, it is advisable to set the redemption price at no more than 2x or 2.5x the investment principal.
- Credit for distributed profits: Require that dividends and interest received from the company be deducted from the redemption price.
- Right to installment redemption: Seek an agreement allowing the founder to pay the redemption proceeds in installments, easing the pressure of a one-time payment.
V. Impact of the New Company Law on the Redemption Right
The newly revised Company Law, effective July 1, 2024, has an important impact on the exercise of the redemption right, which founders need to pay special attention to:
(1) Capital Reduction Procedure for Company Repurchase
Articles 224 and 225 of the newly revised Company Law regulate the company’s capital reduction procedure. If the repurchase obligor is the company, the capital reduction procedure must be completed first, including:
- The shareholders’ meeting passes a resolution on capital reduction (to be adopted by shareholders representing more than two-thirds of the voting rights);
- A balance sheet and a property list are prepared;
- Within ten days from the date of the capital reduction resolution, creditors are notified, and within thirty days a public notice is published in a newspaper or on the National Enterprise Credit Information Publicity System;
- Creditors have the right to require the company to repay its debts or provide corresponding security.
The complexity and uncertainty of the capital reduction procedure make investors generally unwilling to accept the company as the repurchase obligor. This is also an important reason why the founder’s personal undertaking of the repurchase obligation has become the mainstream arrangement in practice.
(2) Simplified Capital Reduction Procedure
Article 225 of the newly revised Company Law introduces a “simplified capital reduction” system, allowing a company that still has losses after using its reserves to make up for losses to reduce its registered capital to offset the losses. However, a simplified capital reduction may not distribute to shareholders, nor exempt shareholders from their obligation to pay in capital. Therefore, the simplified capital reduction offers limited help to investors in exercising the redemption right.
(3) Accelerated Maturity of Shareholders’ Capital Contributions
Article 54 of the newly revised Company Law provides that where a company is unable to discharge its due debts, the company or its creditors may require shareholders who have subscribed capital but whose contribution period has not yet arrived to pay in their capital in advance. If the founder is also a shareholder of the company and has unpaid-in capital, upon failure of the VAM and facing redemption debts, they may be required to pay in capital early, further aggravating the financial pressure.
VI. Practical Points on Exercising the Redemption Right
(1) Exercise Period
The redemption right is usually subject to an exercise period. The investment agreement will provide that the investor shall exercise the redemption right by written notice to the founder within a certain period (e.g., 6 or 12 months) after the triggering condition is satisfied; if not exercised in time, the redemption right is extinguished.
Founders should note: in some agreements the investor’s redemption right may exist for a long time (e.g., “at any time after the redemption trigger condition is satisfied”), which is extremely unfavorable to the founder. Founders should seek a clearly agreed exercise period, giving the founder a definite “safe period.”
(2) Payment Period for Redemption Proceeds
The investment agreement should expressly provide the time within which the founder must pay the redemption proceeds after a redemption notice is issued (e.g., 90 or 180 days). Founders should seek a longer payment period and the right to pay in installments.
(3) Joint and Several Liability for the Repurchase Obligation
If the company has multiple founders, the investment agreement may provide that all founders bear joint and several liability for the repurchase obligation. This means any founder is obliged to pay the entire redemption proceeds and may then seek contribution from the other founders.
Founders should seek to provide that the repurchase obligation be shared in proportion to shareholdings rather than joint and several liability. Otherwise, a more capable founder may be forced to bear a repurchase obligation exceeding their share.
(4) Conflict Between Redemption and Co-Sale Rights
Investment agreements usually also contain clauses such as the co-sale right and the right of first refusal. Founders should pay attention to whether these clauses conflict with the redemption right and whether the investor may exercise multiple rights simultaneously.
VII. Legal Risks Faced by Founders
(1) Risk of Unlimited Personal Liability
This is the greatest threat the redemption right clause poses to founders. If the founder undertakes the repurchase obligation in a personal capacity and no liability cap is agreed, the founder must perform the obligation with all of their personal assets. Even if the company goes bankrupt, the founder’s personal debt remains.
(2) Risk of Community Debts of Spouses
Under Article 1064 of the PRC Civil Code, debts incurred by one spouse for the daily needs of the family during the marriage fall within community debts of the spouses. Although whether a redemption debt constitutes a “community debt of the spouses” is disputed in judicial practice, some courts have ordered the founder’s spouse to bear joint and several repayment liability.
(3) Risk of Being Listed as a Judgment Debtor Subject to Enforcement
If the founder is unable to pay the redemption proceeds, the investor may apply to the court for compulsory enforcement. The founder may be included in the list of judgment debtors subject to enforcement (colloquially known as a “deadbeat”), facing punitive measures such as restrictions on high consumption, exit from the country, and taking flights or high-speed trains, which seriously affect personal life and commercial reputation.
(4) Risk of Losing Control
If the founder uses company equity to satisfy the redemption debt, it may cause the founder’s shareholding ratio to drop significantly and even lose control of the company. In extreme cases, the investor may gain control of the company by acquiring a large amount of equity, squeezing the founder out of management.
VIII. Recommendations: How Founders Can Guard Against Redemption Risks
Seven key strategies for negotiating the redemption right:
1. Seek the company as the first-priority repurchase obligor: Although a company repurchase is restricted by the capital reduction procedure, designating the company as the first-priority repurchase obligor and the founder as bearing only supplementary liability can, to a certain extent, isolate the founder’s personal risk. When the investor requires a personal guarantee from the founder, seek to limit the founder’s liability to the value of the company equity they hold.
2. Strictly limit the trigger conditions: Avoid accepting overly broad redemption triggers. For example, refine “material breach by the founder” into a specific list of circumstances to avoid an expansive interpretation of “catch-all clauses.” Seek to tie the non-listing trigger to the capital market environment, such as “failure to list not caused by the company.”
3. Set a cap on the redemption price: Firmly seek a redemption price cap clause, such as “the redemption price shall not exceed 2x the investment principal.” At the same time, seek mechanisms that reduce redemption cost, such as simple-interest calculation and credit for dividends already received.
4. Agree on a grace period and installment payments: Seek a 6–12 month grace period after redemption is triggered, and agree that the founder has the right to pay the redemption proceeds in 3–5 installments. This gives the founder time to seek alternative financing or facilitate a sale of the company.
5. Set a “sunset clause” for the redemption right: Seek an agreement that the redemption right automatically lapses after a certain period (e.g., 7 years after the investment is completed), or automatically terminates as the company reaches certain milestones (such as a valuation exceeding a certain amount or completion of a new round of financing).
6. Avoid cross-default clauses: If there are multiple rounds of investors, resolutely avoid a cross-default clause providing that “the exercise of the redemption right by any one investor triggers the redemption right of all investors.” Otherwise, the action of one investor may trigger a run-on effect.
7. Properly isolate personal assets: Before financing, founders should legally separate personal assets from family assets, such as through a family trust or prenuptial/marital property agreements, to reduce the impact of a failed VAM on the family. At the same time, avoid converting VAM debts into community debts of the spouses.
IX. Conclusion
The redemption right clause is one of the most “devastating” clauses in an investment agreement. It lies silently in the text of the agreement, but once triggered, it may expose the founder to the legal consequence of losing everything.
Lawyer Kevin Jun Lin has always believed that the core of financing negotiation is not “getting the money,” but “sustainably getting the money while retaining control.” Every investment agreement you sign sets the rules for your future self. Those clauses that you thought at the time “would never be triggered” may well become reality one day.
The redemption right is not something you cannot sign, but it must be signed only on the premise of fully understanding its legal consequences, and through negotiation you should seek reasonable protective boundaries. Remember: every minute of prudence at the time of signing may save you tens of millions or even hundreds of millions in the future.
Further Reading
If you need professional support in shareholder agreements, investment term review, or equity disputes, please contact Lawyer Kevin Jun Lin (Shenzhen corporate lawyer) for a one-on-one consultation.
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