Last Updated on December 18, 2022 by Anda Malescu
The article discusses what is a put option in a shareholders’ agreement and how to draft this vital part of the shareholders’ agreement.
“Put options” just like “call options” are frequently used in shareholders’ agreements throughout the United States. As you know by reading our other articles, a shareholders’ agreement specifies the rights and obligations of shareholders and sets out the manner in which the company will be governed.
In Florida, shareholders’ agreements are present in the context where a business is incorporated and organized as a corporation
Upon formation, the corporation becomes a legal entity independent from its owners and issues shares or stock certificates to individuals or entities in exchange for capital invested in the company. In other words, the corporation raises money through sale of shares to individuals and companies. Once the individuals or other entities purchase shares in the corporation, they become shareholders and get all the rights and benefits deriving from ownership of stock under state and federal law. Of course, we are discussing here only about a non-public corporation, but the corporation can also be an incorporated joint venture.
What is a put option?
A put option clause in a shareholders’ agreement is a right but not an obligation to sell the shares at a specified price upon the occurrence of a specified event. Practically, a put option clause gives a shareholder the right to sell their shares back to the company at some price, either a fixed sum or an amount determined by a formula, at some specified time in the future. For example, let us say that there are two shareholders in a company – Shareholder 1 and Shareholder 2. Shareholder 1 invests $10,000 in exchange for shares in the company and Shareholder 2 invests $15,000.
Shareholder 1 wants to continue being a shareholder in the company only if the company generates a certain amount of revenue after five years; if not, Shareholder 1 wants to exit. A put option clause included in the shareholders’ agreement over Shareholder 1 shares gives this shareholder a right, at their option, to require that the company repurchases the shares at some predetermined price or by some predetermined formula.
However, there are other scenarios in which having a put option in a shareholders’ agreement can be useful
Assume for example that there are two shareholders in an incorporated joint venture company – A and B. Shareholder A is concerned that B may default on the shareholders’ agreement and will not be able to correct the defect. To reduce the risk of loss for A, a shareholders’ agreement can provide for a put option mechanism by which A can sell the shares to B and exit the company when a default occurs. In this case, A has a right to require that B repurchase A’s shares at some price when a default arises, and B can continue in the company.
A put option in a shareholders’ agreement is an important mechanism to reduce the risk of loss of capital for the shareholders and provides a convenient device for withdrawing investment in a business. In order to be effective, a put option should be precise as to whether the shareholder has a right to sell shares, specify the amount or percentage of shares that are subject to put option and be in harmony with any applicable state and federal laws.
Contact us or schedule a consultation with your business lawyer in Miami, Florida USA to and help you plan and execute a put option clause in a shareholders’ agreement.
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