Mandatorily Redeemable Shares What it is How it Works Example
Mandatorily Redeemable Shares: What it is, How it Works, Example
What Are Mandatorily Redeemable Shares?
Mandatorily redeemable shares are owned shares that must be redeemed for cash or another 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 in the future.
Mandatorily redeemable shares are often issued by employers to workers as compensation. In this context, the employer requires employees to redeem these shares for cash or bonds and attaches the redemption requirement to specific events or timelines.
Key Takeaways
– Mandatorily redeemable shares can be redeemed for cash or other property at a stated time or following a specific event.
– They are often issued by employers as part of a compensation package to entice new employees.
– The SEC and FASB have issued regulations concerning accounting for mandatorily redeemable shares.
Understanding Mandatorily Redeemable Shares
One example of a situation where an employer would issue mandatorily redeemable shares is when an employee quits. The employer exercises its "call" option on these shares, forcing the employee to sell back their company shares. An employer may do this if 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 should account for mandatorily redeemable shares. This is because these shares have characteristics of both liabilities and equity.
Regulations from the SEC state that 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 FASB 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, they will be forced to sell back the shares to the company at the stated price if ABC exercises its call option.
