Investors Trapped in Repurchase Agreements

By Muxin Xu

Edited by Zhiyan Chen

When seven repurchase agreements landed on his desk, investor Li Lei felt a sudden pang of melancholy. Back when he first met these founders, he'd imagined them becoming the next Salesforce or MongoDB, delivering 1000x returns. During investment committee meetings, his only concern had been whether Hongshan or Hillhouse Capital would join the next round. Never did he imagine it would come to this — having legal counsel pore over repurchase clauses.

Throughout 2023, Li Lei's situation was far from unique among investment institutions.

"Repurchase" is a downside protection mechanism for investors. When a portfolio company hits trouble and triggers repurchase terms, it serves as compensation for invested capital. Market-standard repurchase interest rates currently run 8-10%, with exceptional cases reaching 20%. Though repurchase agreements exist in virtually every equity investment transaction, they were previously treated as "gentlemen's agreements" or mere formalities. After all, these interest rates were laughable compared to the "100x myth" of IPO exits.

The shift began in 2022.

According to AMAC data, corporate repurchases accounted for roughly 20% of exits in 2022, while public market exits represented only about 17% — a ratio that has remained largely stable over the past three years. Repurchase has become the only "certainty" investors can grasp in today's exit dilemma, and in some sense, a way to stop the bleeding.

Two factors most clearly explain this attitudinal shift: first, IPO exits face mounting obstacles. Second, a wave of funds founded during the easy-money era are approaching their exit deadlines. In theory, with exit pressure mounting, initiating repurchases should be straightforward. Reality proves far more complex than the contract language suggests.

"The repurchase clause investors cling to is like a phantom branch. They're already being swept away by the current, they spot a stick, but when they reach for it — it's gone," Wang Chao told Anyong Waves.

In 2021, Wang Chao founded Blue Bridge Capital, a boutique investment bank focused on complex technology transactions spanning M&A, corporate carve-outs, and private equity financing. During this year of flying repurchase agreements, serving as intermediary between investors and founders, Wang Chao has observed from his corner of the industry the predicaments facing different players.

In his observation, founders "subjected to repurchase" sometimes react in bewildering ways — one founder, in a fit of rage, fired off an email to all shareholders on a weekend night with an unmistakable scorched-earth tone. Yet beyond such incidents, even investors initiating repurchases seem swept along, either mechanically numb and acting against their will, or mired in quicksand themselves.

A Vicious Cycle

Over the past six months, Sherry has distinctly felt an "exit anxiety" spreading through her firm.

She works at a corporate venture capital platform under a listed conglomerate. At an internal meeting, she recorded the following "key directives" from a partner:

1. Successful repurchases always break conventions. Hunt for evidence of founders' financial embezzlement or misappropriation, while applying constant pressure.

2. Take exit action first, study exit mechanisms later.

3. Exits matter more than investments. The measure of an investment team's competence is exits.

In short, a core philosophy — "exits above all, by any means necessary." Under this "guiding ideology," repurchase became the chosen "exit tool" for many projects. Theoretically, multiple exit paths exist: M&A, secondary transactions, and old share transfers can all serve as alternatives to IPO. But correspondingly, these three methods require finding the next buyer to keep the "hot potato" game going.

Repurchase is different — it involves no third party, just a matter between investor and founder to resolve.

Though internally the firm has reached a state where exits dominate every conversation, actual repurchase execution proves extraordinarily difficult. Sherry observes colleagues showing little enthusiasm for pushing repurchases. "These are their own deals, they've maintained good relationships with founders. Even if they leave this institution later, they don't want to burn bridges and sue for repurchase."

Wang Chao told Anyong Waves that from a legal classification standpoint, repurchase execution basically falls into three scenarios:

1. Company bears repurchase obligation: This requires first completing capital reduction procedures. But per most company charters, this needs approval from over two-thirds of shareholders — which founders will almost certainly not cooperate with. Additionally, under Company Law Article 166, company profits must first cover losses and 10% statutory reserve funds, placing investors very low in priority.

2. Founder bears supplementary joint liability for repurchase payment: But here the primary creditor remains the company. Without a court judgment against the company, investors cannot pursue the founder's liability.

3. Founder bears independent personal liability for repurchase: Only in this scenario do courts recognize founders being directly sued to repurchase old shares. But this typically limits founders' repurchase obligation to their personal equity stake in the company — equity that by this point may already be worthless.

Thus, while it appears that institutions initiating repurchase have "exited" a portfolio company, the actual destination remains distant.

Wang Chao cited a recent repurchase lawsuit he experienced: First, investors send a formal notice to the company, stating they will repurchase shares by December 31st. Seasoned entrepreneurs typically respond by ignoring it. Next, investors may convene a general shareholders' meeting to again urge repurchase. If the entrepreneur still ignores this, investors may proceed to arbitration.

Per standard repurchase agreements, the process involves the company using its book cash to repurchase shares from shareholders, then canceling those shares — but cancellation requires unanimous shareholder consent. In extreme cases, even forced votes need over two-thirds approval, which founding major shareholders generally won't grant.

Consequently, arbitration becomes a protracted tug-of-war, followed by even more cumbersome litigation, potentially stretching over years. "If this doesn't conclude soon, we'll all be old."

Investors know this full well. So why embark on a repurchase path that's destined to be tortuous, lengthy, and unlikely to yield high returns?

Wang Chao offers one observation — many investors don't actually want the repurchase payment or its 10% interest.

"Some investors raise repurchase demands with great fanfare, then let them drop lightly." In his advisory work, Wang Chao found that many investors may not truly want the company to repurchase, but rather use repurchase as a "lever" to gain more corporate control. "Or, use repurchase clauses to have founders help find a solution — like finding someone to take over old shares."

Thus, in such cases, the act of proposing repurchase matters more than actually receiving payment.

After enduring multiple internal "struggles," Sherry discovered another answer: the driving force behind her firm's aggressive repurchase initiation and exit-seeking likely stems from the big boss himself having signed repurchase agreements across several subsidiary projects under the group. When these multiple repurchase clauses trigger simultaneously, the boss must find the fastest capital recovery method — such as pressing the fund GPs he invested with to exit quickly and return capital. Repurchase becomes one such tool.

The industry loves telling that beautiful story: "the investor who backed founders when they were unknown, later repaid by the company grown into a giant becoming their LP." But as venture capital moves past its wild-west era into transformation and upgrading, the story's flip side surfaces: founders and investors, bound together by the same repurchase agreement, form a vicious cycle. And this cycle will continue spreading to other corners of the world, with no winners in the end.

The Tragedy of Passive Correctness

"Everyone's initiating repurchases, but in the end nobody knows why. Pretty terrifying, right?"

In numerous repurchase cases, Wang Chao has observed a somewhat eerie phenomenon: all participants are passively swept into it.

Bob, an investor at a well-known dollar fund, recently vented to Anyong Waves about difficulties he's facing. In 2019, the fund invested in a project as its Series B investor. For years afterward, everything flourished — larger dollar funds came in, and at its Series F peak valuation, the company even attracted state-backed RMB investors.

When money floods in like a tide, everyone standing in the water assumes the waves won't recede. In 2021, the company confidently signed a repurchase agreement with a state institution, betting on IPO within two years. They didn't anticipate that 2022's pandemic would hit their business, causing this year's IPO to stall. To make matters worse, the state investor initiated repurchase before the December 31, 2023 deadline.

Repurchase success rates and timelines depend on the nature of both parties. In this case, with a domestic corporate structure and a state-backed investor, what might take years in overseas proceedings could wrap up in a month.

Gone is the founder's early-year swagger; now he seeks the fastest path to profitability, such as layoffs.

State capital, now center stage, has encountered dollar funds — battered by recent lean years — within repurchase clauses. With loss-averse expectations, many companies have lately faced repurchase demands from state investors.

Wang Chao recently encountered a similar case: after two companies merged, it triggered a state institution's repurchase clause. Though the merged entity had prospects for listing on the Beijing Stock Exchange or STAR Market, this couldn't retain the state institution's capital. The founder now only resents having too much cash on hand — just enough to cover the repurchase payment, and just enough to leave the company struggling to survive after paying.

This sets off a chain reaction, not only tormenting founders but also triggering avalanches among investors behind them.

Bob explained to Anyong Waves: If one institution in the Series F round initiates repurchase, all investors in that round will follow suit based on risk mitigation — a protective action for their underlying LPs. But repurchase execution spreads from latest round to earliest. The most likely outcome is that only the last-round investors receive full repurchase payment, by which point the company's cash is nearly depleted, cash flow interrupted, and the company likely dies. For earlier-round investors (regardless of whether they're dollar funds), it's total loss.

Moreover, even recovering principal means little for funds with the smallest ticket sizes and longest investment horizons. Even 10% annual interest doesn't make this an investment — it's an unprofitable debt recovery.

Thus in such situations, earlier-round investors actually side with founders against repurchase clauses. Bob is trying to help — he's been busy lobbying the state investor executing repurchase, attempting to give the company more confidence and accept a phased repurchase buffer solution. But Bob himself admits this is extremely difficult.

"State institutions typically make collective decisions, and in this case leadership changed mid-stream, project managers rotated, and the team that originally invested is gone. Taking over someone else's project, they'll definitely approach any future decisions with a risk-avoidance mindset," Bob told Anyong Waves.

In many cases, from junior investment managers up to GP partners, those initiating repurchases are being pushed along rather than acting of their own volition. When investors consult Wang Chao on repurchase execution, he sometimes asks why they're initiating repurchase, whether they know how much they'll ultimately receive. The responses are simple: "The boss told me to initiate repurchase," or "I'm leaving next year, I don't know how much I'll get."

On the other hand, since repurchase targets are mostly founders they once believed in and bet on, the emotional tearing is part of what creates this passive mentality for many institutional investors. Thus, in many internal repurchase discussions, the most frequently mentioned phrase is "business is business" — everyone seems to use these four words to compensate for some emotional deficit.

"This is inertia — initiating repurchase for repurchase's sake," Wang Chao says. "But for many investors, the reality is they can't withstand internal pressure anymore. If they don't initiate repurchase, they can't cover themselves either."

Whether it's early-stage institutions using repurchase agreements as leverage while actually wanting to sell old shares, junior investment managers mechanically executing their boss's will, or institutions treating investments as debt and refusing risk — everyone is doing the correct thing from their position, yet tragedy unfolds.

Compared to operationally complex M&A, secondary funds dependent on buyers, or old share transfers, repurchase is the exit method least constrained by external parties when institutions seek quick exits — requiring only communication with the portfolio company. But quick and effective doesn't mean it should be so.

If we return to venture capital's origins, from Arthur Rock's push to establish Fairchild Semiconductor that birthed Silicon Valley's mythology, VC's creation of enormous wealth, identification of the most valuable seeds, and realization of the most impractical dreams — such stories are countless.

But if venture capital's romanticism has died, then is repurchase the only exit path for investors seeking liquidity? Should portfolio companies be sacrificed as the price? This is the answer everyone is searching for in the new year.

(At interviewees' request, Li Lei, Bob, and Sherry are pseudonyms.)

Image source: Visual China

Layout: Muxin Xu