Venture capitalists invest in startup companies with the expectation of realizing an exit in order to pay back their limited partners. In some situations, however, management may not be as focused on realizing an exit as there may be incentive misalignment when it comes to liquidating the company. This is most likely to happen in situations where 1) the company is generating enough cash to make the founders wealthy from dividend payments or 2) the management team does not have the right mix of options in their compensating plan, leaving either party with less incentive to aggressively pursue an exit.

As a result, VCs often require that they receive redemption rights when they invest. These rights enable the investors to force the company to buy the investor’s shares back from them after a specified period of time for a specified value. The specified period of time is often a period that is sufficient for the company to pursue an exit if the company performs (often five years or more). This is an important point, as this term is not designed in spirit to provide VCs with early liquidity, but rather to give the VCs a means of realizing liquidity if an exit has not been pursued. The value of the equity is often the fair market value at the time that the redemption is enacted.

These rights are commonplace and shouldn’t be cause for concern for entrepreneurs that intend to exit their company. If it is your intention to maintain an independent, private entity in perpetuity, never giving your investors a liquidity event, however, you should communicate that to your investors before taking their money and you should not seek traditional venture capital.