Recoupment - Explained
What is Recoupment?
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Table of ContentsWhat is Recoupment?How does Recoupment Work? Recoupment in Angel Investments Recoupment in the Music IndustryAcademic Research on Recoupment
What is Recoupment?
Generally speaking, recoupment refers to a recovery of expenses. The term has several implications. In the context of investments made by a business in areas such as research and development, recoupment means a direct or indirect recovery of the investment through remunerative undertakings such as product sales or licensing agreements.
Recoupment may also refer to the right of a respondent to petition the court of law to mitigate or dismiss a plaintiff or litigators claim due to the plaintiffs violation of the same contract that the litigation is based on. In angel investing, recoupment refers to ways in which angel investors recover their investments from stalled start-ups.
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How does Recoupment Work?
Recoupment is the act of recovering past investments or losses by selling an asset or a part thereof so that the proceeds from the sale are sufficient to cover the investment or loss. The practice of recoupment is most widespread in the music industry, where record labels use it to claim advances that they paid to (especially debutant) artists.
Recoupment in Venture Capital
Investing in just one startup with potential for success can work wonders for an angel investors portfolio. Angel investors invest million of dollars in such ventures in hopes of gaining ownership equity or convertible debentures. These investors realize profits through positive exits on their investments. However, not all exits are positive.
Oftentimes, startups go out of business, resulting in negative exits. However, the worst case scenario is when ventures stall after breaking even, i.e. they neither grow nor head toward a positive exit. A stall invariably forces investors to seek out ways to recover their investments, or, in other words, initiate the recoupment process. In most cases, angel investors are unable to recover the full value of their investments; nevertheless such efforts have often proved to be fruitful.
Recoupment can be enforced in either of the following ways:
- By selling shares back to the company.
- By selling shares to another shareholder.
- By running an auction with the consent of all investors.
- By allocating shares to all investors.
- By creating non-profit funds where investors can donate shares in return for a tax loss on the investment.
- By selling shares in stock exchanges or online platforms.
It should be noted here that it is not always a straightforward task to sell shares back to the startup company - often, startups do not possess sufficient capital to buy their shares back. Selling shares to another shareholder is an excellent method of recoupment provided the other shareholder has maintained a bullish position on the company or has an emotional stake in it.
Distributing shares among investors is not a very desirable option and is usually treated as a last resort. Similarly, while it might be relatively easy to dispose of shares in secondary markets, investors are often forced to sell their shares at throwaway prices.
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