Mandatorily Redeemable Shares: What it is, How it Works, Example

What Are Mandatorily Redeemable Shares?

Mandatorily redeemable shares are shares owned by an individual or entity which are required to be redeemed for cash or another such property at a stated time or following a specific event. Essentially, they are shares with a built-in call option that will be exercised by the issuer at a pre-determined point in the future.

Mandatorily redeemable shares are often issued by employers to workers as a sort of compensation kicker. In this context, the employer usually requires the employees to redeem these shares for cash or bonds and attaches the redemption requirement to certain prescribed events or timelines.

Understanding Mandatorily Redeemable Shares

One example of a situation where an employer would issue mandatorily redeemable shares would be in the case of an employee quitting the firm. The employer would exercise its "call" option on these shares, forcing the exiting employee to sell back their company shares. An employer might do this in a situation where the shares are restricted and greatly in the money, or if it is a closely-held company with relatively few shares in float.

In the past, there have been irregularities and ambiguities surrounding how the issuer of mandatorily redeemable shares should account for them on their books. This is because mandatorily redeemable shares have characteristics of both liabilities and equity.

Under regulations from the Securities and Exchange Commission, securities must be classified outside of permanent equity if they can be redeemed for cash or other assets at a fixed or determinable price in the future; at the option of the holder; or upon the occurrence of an event outside the control of the issuer. Statement 150 from the Financial Accounting Standards Board outlines when mandatorily redeemable shares must be considered a liability on a company's financial statements.

Example of Mandatorily Redeemable Shares

Company ABC issues redeemable stock that are mandatorily redeemable at a liquidation preference of $40 three years later. This means the company has the option to buy back the shares at the price of $40 after a set time period of three years. If the company has issued the stock to an employee or investors, then they will be forced to sell back the shares to the company at the stated price (irrespective of valuation in the private or public markets), if ABC exercises its call option.