Redeemable Shares: What Startups And SMEs Need To Know

If you’re raising capital for your startup or SME, you’ve probably heard investors (or your accountant) mention redeemable shares. It can sound like a technical, investor-only concept - but it’s actually a practical funding tool that can help you balance growth, control, and risk.

Redeemable shares can be especially appealing when you want to bring in money now, while keeping a pathway for the company to “buy back” those shares later. They can also be used as part of a succession plan or internal restructure.

But like most things in corporate law, the details matter. If you get the structure wrong (or the documents don’t line up), redeemable shares can create confusion, investor disputes, or even compliance issues when it’s time to redeem.

Below, we’ll walk you through what redeemable shares are, why businesses use them, the key legal concepts to understand in Australia, and what you’ll want properly documented before you issue them.

What Are Redeemable Shares (And Why Do They Matter)?

Redeemable shares are shares issued by a company that can be “redeemed” - meaning the company buys them back and cancels them - in certain circumstances.

In plain terms: redeemable shares let you raise money today, while building in a mechanism for those shares to be returned to the company in the future (often for a pre-agreed price or a price determined by a formula).

Redeemable Shares vs “Normal” Shares

Most people think of ordinary shares as something you buy and hold indefinitely (or until you sell them to someone else). Redeemable shares are different because they’re designed with an “exit switch” built in.

That “exit switch” might be triggered:

• at a set time (for example, 3 years after issue)
• when a certain event happens (for example, a new funding round, a change of control, or an IPO)
• at the option of the company (company can choose to redeem)
• at the option of the shareholder (shareholder can request redemption), depending on how the rights are drafted

Are Redeemable Shares A Separate “Class” Of Shares?

Often, yes. Redeemable shares usually sit within a specific class of shares with their own rights attached (such as redemption rights, dividend rights, or voting rights).

It’s common for startups and SMEs to create a capital structure with different classes of shares so that founders, employees, and investors can hold shares with different rights and protections.

Why Would A Startup Or SME Use Redeemable Shares?

Redeemable shares can be useful when you want funding flexibility without permanently changing your ownership structure.

Here are some common business reasons you might consider redeemable shares.

1. You Want A Clear Buy-Back Pathway

If an investor is supporting your business early, but you (and they) want a cleaner mechanism to exit later without needing to find a third-party buyer, redeemable shares can provide that path.

Instead of relying on a share sale to another investor, the company can redeem (buy back and cancel) the shares under the agreed rules.

2. You Want Funding That Looks More “Temporary” Than Ordinary Equity

Sometimes, redeemable shares are used in situations that are equity in form, but closer to a “capital injection with a planned return” in substance.

This can be attractive where:

• your business isn’t ready for a full valuation negotiation
• you want to avoid permanent dilution
• the investor wants a clearer exit timeline

3. You’re Trying To Balance Control And Investor Rights

Some founders worry that issuing ordinary voting shares gives away too much influence too early. While you can’t ignore investor expectations, a thoughtfully drafted redeemable class can sometimes help balance:

• cashflow needs (capital now)
• control (voting rights may be limited or structured)
• exit (redemption terms agreed upfront)

Of course, the “right” structure depends on your bargaining position and the investor’s risk appetite.

4. You’re Planning A Succession Or Family Business Arrangement

SMEs sometimes explore redeemable shares for family business planning - for example, allocating economic benefits while keeping a mechanism to redeem shares later as circumstances change.

Where this intersects with transfers, it’s also worth thinking about the mechanics of how you’ll transfer shares (and any restrictions in your constitution or shareholder agreements).

How Do Redeemable Shares Work Under Australian Company Law?

In Australia, redeemable shares are governed by the Corporations Act 2001 (Cth) (including the capital maintenance rules in Part 2J.1) and your company’s governing documents.

At a practical level, redeemable shares only work smoothly when these three layers line up:

• The Corporations Act rules (including rules about capital maintenance and how redemptions must be funded)
• Your company’s constitution (or replaceable rules, but constitutions are common for startups)
• The deal documents (term sheet / share subscription terms / shareholders agreement)

If your constitution doesn’t allow for the class and redemption mechanics you want, the redemption provisions may be ineffective or create uncertainty.

That’s why it’s common to update your Company Constitution (or adopt a tailored one) before issuing a new redeemable class.

Redeeming Shares Is Not The Same As Buying Shares From A Shareholder

It’s important to separate two concepts:

• Redemption: the company redeems and cancels the shares according to the rights attached to them.
• Share buy-back / transfer: a shareholder sells shares (often to another shareholder or to the company), and ownership changes hands.

Redemption is usually more “built-in” to the share class. Transfers can be more flexible, but may require more negotiations and approvals at the time.

Can A Company Redeem Shares Whenever It Wants?

Not automatically. Whether shares are redeemable, and the exact method of redemption, depends on the rights attached to those shares and what your company documents say.

Also, companies generally need to be careful about how the redemption is funded. Under Australia’s capital maintenance rules, a redemption generally needs to be funded out of profits or out of the proceeds of a fresh issue of shares made for the purpose of the redemption (and there are rules about timing and procedure). Companies also need to consider solvency and creditor protection - a company shouldn’t redeem shares if doing so would put it in financial difficulty or breach directors’ duties.

Depending on the broader arrangement, it may also be important to check whether any related rules are triggered (for example, share buy-back provisions or financial assistance restrictions), particularly if the company or related parties are providing funding or security connected with the transaction.

This is where proper structuring and advice is crucial - particularly if redemption is planned at a time when cashflow might be tight.

Key Terms To Get Right In A Redeemable Share Structure

Redeemable shares are not a “one-size-fits-all” instrument. The commercial terms you agree (and how they’re drafted) make all the difference.

Below are key terms businesses typically need to decide.

1. Who Has The Right To Trigger Redemption?

Redemption might be:

• Company option: the company can choose to redeem (often helpful where the company controls timing based on cashflow)
• Investor option: the investor can request redemption (often more attractive to the investor, but it can create cashflow pressure)
• Automatic: redemption occurs on a set date or event

If the investor has the ability to force redemption, you’ll want to think carefully about worst-case scenarios (for example, if your business hits a slow period right when redemption is due, or if the company can’t legally fund the redemption at that time under the Corporations Act).

2. What Is The Redemption Price?

The redemption price might be:

• a fixed amount (for example, $1.00 per share)
• issue price plus a premium (similar to a return)
• a formula tied to performance (for example, EBITDA multiples)
• fair market value at the time, determined by an agreed valuation method

This is one of the biggest commercial points in the deal. If you set a price that’s too high, redemption can become unrealistic. If you set it too low, investors may not accept the risk.

3. What Happens If The Company Can’t Pay On Time?

This is a practical question that too many businesses skip early on.

Your documents should be clear on what happens if redemption is triggered but the company:

• doesn’t have sufficient cash at the time
• cannot legally fund redemption in the intended way (for example, because the required funding source or timing requirements aren’t met)
• needs to stage redemption over a period

A well-drafted approach might allow instalments, deferral, or alternative outcomes (like conversion into another class), but it needs to be written clearly to avoid disputes.

4. Do Redeemable Shares Carry Voting Rights?

Some redeemable shares are structured with limited voting rights, especially if their purpose is closer to a financial investment than long-term governance.

However, investors may want certain voting protections, like voting on major decisions (for example, selling the business or issuing new shares).

This is often documented in a Shareholders Agreement alongside the company’s constitution.

5. Do Redeemable Shares Receive Dividends (And Are They Priority Dividends)?

Some redeemable shares may have dividend rights that are different to ordinary shares - including preference-style rights.

For example, the class might receive dividends before ordinary shareholders, or receive a specified dividend rate if declared.

If your business plans to reinvest profits (common in startups), be careful about promising dividends you’re unlikely to declare.

6. Conversion Rights (If Any)

In some deals, redeemable shares may also be convertible into ordinary shares, particularly where the investment is meant to “behave” differently depending on the company’s growth.

Sometimes, businesses compare redeemable shares with instruments like share options - but they’re different tools. Options usually give a right to buy shares later, while redeemable shares are already issued shares that may be bought back and cancelled later.

What Documents Do You Need When Issuing Redeemable Shares?

If you’re going to issue a redeemable class, you want the paperwork to be consistent and future-proof (because you might not think about these terms again until it’s time to redeem - and that’s when gaps become expensive).

Common documents to consider include:

• Company Constitution updates: your constitution should clearly allow the class, the redemption mechanics, and any special rights (this is where the Company Constitution becomes central).
• Shareholders Agreement: this usually covers governance rules, reserved matters, exit pathways, and investor protections in a way that works alongside the constitution (often done through a Shareholders Agreement).
• Share subscription / issue terms: the commercial deal terms for the investor’s subscription, including timing, price, conditions, and any warranties.
• Board and shareholder resolutions: company approvals to create the class (if required), issue the shares, and update registers.
• Cap table and registers: accurate records of who owns what, and what rights attach to each class.
• Share certificates (if you issue them): if your company issues certificates, they should correctly reflect the class and ownership details - and your records should stay consistent with the share certificates you provide.

Even if you’re moving fast, it’s worth slowing down long enough to get the foundation right. Redeemable arrangements often “sit quietly” until a trigger event happens, and then everyone suddenly cares about the fine print.

Common Risks And Mistakes With Redeemable Shares

Redeemable shares can be a great tool - but we often see disputes happen because the structure was treated like a template, rather than tailored to the business.

Here are some common issues to watch out for.

1. The Constitution Doesn’t Actually Support The Redemption Mechanics

One of the most common (and avoidable) problems is issuing redeemable shares without updating the constitution or clearly setting out class rights.

When that happens, you might have:

• uncertainty about whether the shares are redeemable at all
• unclear triggers or timing
• misalignment between investor expectations and legal reality

2. Redemption Obligations That Don’t Match Realistic Cashflow

If redemption is set at a fixed time with a fixed premium, the company might be locking itself into a future payout that doesn’t match how the business actually performs - and it may also be setting itself up for a redemption obligation it can’t lawfully fund at the time.

It’s worth modelling the “what if” scenarios, including:

• slower-than-expected growth
• a delayed funding round
• a downturn in your industry
• unexpected expenses (tax, supply chain issues, staffing costs)

3. Confusion Between Redemption And Transfer / Exit Provisions

If your shareholder documents have both:

• redemption rights (company buys back and cancels shares), and
• transfer rights (shareholders can sell shares to others)

you want those pathways to work together, not compete with each other.

For example, if an investor wants to exit, do they first try to redeem? Or can they transfer shares to a third party? Are there restrictions? Do existing shareholders get first right of refusal?

Clarity here can prevent conflict later.

4. Not Aligning Investor Protections With Governance Reality

Investors often want protections around major decisions. Founders often want to keep the business agile.

Redeemable shares don’t automatically solve this tension - they just add another layer of rights that must be carefully drafted.

It’s usually better to define governance protections clearly in your constitution and shareholders agreement than to rely on assumptions about what “redeemable” means.

5. Tax And Accounting Surprises

While this article focuses on legal structure, redeemable shares can have tax and accounting impacts depending on how they’re designed (for example, whether they look more like debt or equity).

Before you lock in the terms, it’s a good idea to have your accountant review the proposed structure so you’re not surprised later.

Note: This article is general information only and not legal, tax or accounting advice. Because the tax and accounting treatment can vary significantly depending on the terms and your circumstances, you should get advice tailored to your situation before proceeding.

Key Takeaways

• Redeemable shares are a class of shares that can be bought back and cancelled by the company under agreed rules.
• Startups and SMEs often use redeemable shares to raise capital now while creating a clear pathway for a future exit or buy-back.
• The legal effectiveness of redeemable shares depends on your constitution, the rights attached to the class, your deal documents, and compliance with the Corporations Act (including capital maintenance rules and how a redemption is funded).
• Key terms to get right include who can trigger redemption, the redemption price, cashflow and legal-funding contingencies, voting rights, and dividend/conversion rights.
• Strong documentation (including a tailored Company Constitution, Shareholders Agreement, and accurate records like share certificates) helps prevent disputes later.

If you’d like help issuing redeemable shares or setting up your company’s share structure the right way, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.