Redeemable equity is an ownership interest that the issuer may be required, or may be entitled, to buy back from the holder for cash or other assets. The redemption feature is what makes the label necessary, because an interest that has to be bought back behaves partly like a borrowing, and US reporting rules answer that by putting redeemable shares in one of three places rather than the usual two.
Those three places are liabilities, a separate section outside permanent equity that practitioners call mezzanine, and permanent equity. Which one a given instrument lands in is decided by who controls the redemption and how certain it is, not by what the share certificate is called.
Liability Classification: When Redemption Is Unconditional
The first fork removes the instrument from equity entirely.
A mandatorily redeemable financial instrument is classified as a liability, unless the redemption is required to occur only upon the liquidation or termination of the reporting entity. An instrument issued in the form of shares is mandatorily redeemable if it embodies an unconditional obligation requiring the issuer to redeem it by transferring its assets at a specified or determinable date, or upon an event certain to occur (FASB, Statement of Financial Accounting Standards No. 150, paragraph 9).
The carve-out exists for the entity whose own termination is what triggers the redemption. Where the issuer must be liquidated and ceases to exist when the redemption occurs, the holder’s position is an ownership interest rather than a claim on a going concern, which is why paragraph 9 leaves it in equity (FASB, Statement of Financial Accounting Standards No. 150, paragraph B21). A limited-life partnership or a term LLC is the case it is written for.
The classification can also change with no transaction at all. An instrument embodying a conditional obligation to redeem by transferring assets on an event not certain to occur becomes mandatorily redeemable, and therefore becomes a liability, once that event occurs, the condition is resolved, or the event becomes certain to occur (FASB, Statement of Financial Accounting Standards No. 150, paragraph 10). An owner reaching a retirement date under a buy-sell agreement is the common trigger. The reach of that rule is narrower than it looks: the classification, measurement and disclosure guidance does not apply to mandatorily redeemable financial instruments that are both issued by nonpublic entities that are not Securities and Exchange Commission registrants and mandatorily redeemable, but not on fixed dates or not for amounts that either are fixed or are determined by reference to an interest rate index, currency index, or another external index (FASB Accounting Standards Update 2017-11, paragraph 480-10-15-7A). At a nonpublic issuer that is not an SEC registrant, a share redeemable at a formula or appraised price therefore falls outside it even though it has to be redeemed.
A related rule catches the instrument that is not itself a share. A financial instrument other than an outstanding share which at inception embodies an obligation to repurchase the issuer’s equity shares, or is indexed to such an obligation, and which requires or may require the issuer to settle by transferring assets, is classified as a liability (FASB, Statement of Financial Accounting Standards No. 150, paragraph 11). A forward purchase contract on the issuer’s own shares is caught even though no stock has moved, provided it is settled by transferring assets rather than shares.
Mezzanine Classification: When Redemption Is Outside the Issuer’s Control
Where an instrument survives the liability test but the issuer still cannot prevent redemption, the SEC’s balance sheet rules give it its own caption between liabilities and equity.
The caption covers preferred stock subject to mandatory redemption requirements or whose redemption is outside the control of the issuer, and it applies where the stock has any of three characteristics: it is redeemable at a fixed or determinable price on a fixed or determinable date or dates, whether by a sinking fund or otherwise; it is redeemable at the option of the holder; or it has conditions for redemption not solely within the control of the issuer, such as stock that must be redeemed out of future earnings (17 CFR 210.5-02, item 27).
Read the second characteristic carefully. Redeemable at the option of the holder puts the instrument outside permanent equity; redeemable solely at the option of the issuer does not. Amounts attributable to preferred stock that is not redeemable, or that is redeemable solely at the option of the issuer, go under the ordinary preferred stock caption instead (17 CFR 210.5-02, item 27).
The presentation requirement is specific. The face of the balance sheet states the title of each issue, the carrying amount and the redemption amount, and where the carrying value differs from the redemption amount the accounting treatment of the difference is described in a note (17 CFR 210.5-02, item 27). Two numbers, not one, because the gap between them is the information a reader needs, and only the carrying amount is a balance that foots into the total.
Liabilities
Total liabilities X
Redeemable preferred stock
Series A preferred, carrying amount X
Series A preferred, redemption amount (disclosed) X
Stockholders' equity
Preferred stock, non-redeemable (caption 28) X
Common stock X
Additional paid-in capital X
Retained earnings X
Total stockholders' equity XWhy the Middle Section Exists at All
The mezzanine is not a compromise for its own sake. It exists because the two ordinary categories each say something false about these instruments.
Calling them equity says the capital is permanent, and it is not, because the holder can force cash out of the company. Calling them liabilities says an obligation exists, and it may not, because the condition may never resolve. The separate caption reports the fact as it stands: a claim ahead of the residual holders that the company cannot unilaterally keep.
For a reader running leverage ratios this matters directly, and it is why an analysis that sweeps the mezzanine into equity flatters the borrower. The general ratio treatment of the residual is in equity multiplier, and what stays inside permanent equity is set out in stockholder equity.
The Other Meaning of the Phrase
Venture and impact investors use redeemable equity for a financing structure rather than a balance sheet caption: an equity investment the founders buy back over time on agreed terms, usually out of revenue, so the investor exits without a sale of the company.
The two meanings are related but not interchangeable. The financing structure has to be classified under the rules above like anything else, and where the buy-back obligation is unconditional it will not be equity on the issuer’s books at all. A term sheet that calls an instrument redeemable equity is naming a deal shape, not settling its accounting.
Common Questions
It depends on who can force the redemption and whether it is certain. Where redemption is unconditional and required at a determinable date or on an event certain to occur, it is a liability (FASB, Statement of Financial Accounting Standards No. 150, paragraph 9). Where it is redeemable at the holder’s option or on conditions outside the issuer’s control, an SEC registrant reports it outside permanent equity under the redeemable preferred caption, and a nonpublic non-registrant may sit outside the classification guidance altogether (FASB Accounting Standards Update 2017-11, paragraph 480-10-15-7A). Where it is redeemable only at the issuer’s option, it stays in permanent equity. The same certificate can move between those answers as facts change.
Mezzanine equity is the practitioner’s name for the section between liabilities and stockholders’ equity where redeemable instruments outside the issuer’s control are reported. The rules themselves do not use the word mezzanine, they use the caption for preferred stocks subject to mandatory redemption requirements or whose redemption is outside the control of the issuer (17 CFR 210.5-02, item 27). Temporary equity is the other common informal name for the same section.
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