Option agreements: what are they and what can they be used for?

Understanding Option Agreements

An option is a right that allows the holder (buyer) to buy a share or stake in a limited liability company or private limited company under specified terms. It’s like a “purchase right,” where you have the right, but not the obligation, to buy shares at a specific time at a set price.

What Exactly Is It, and What Does It Entail?

An option agreement differs from warrants as it offers existing shares and generally does not require changes to the company’s bylaws or a general meeting.

Two Main Types of Options

Call Option:

This type of option contract gives the holder (buyer) the right to buy the underlying asset at a specific price before or on a predetermined expiration date. The seller of a call option is required to sell the asset if the holder exercises the option.

Put Option:

Unlike a call option, a put option gives the holder the right to sell the underlying asset at an agreed-upon price before or on a specific expiration date. The seller of the put option is obligated to buy the asset if the holder exercises the option.

When Can the Option Be Exercised?

The option may have an expiry date, after which it can no longer be exercised. It may be limited to certain intervals throughout the year. If the option is not exercised, it can in some cases be replaced by normal pre-emption rights.

What Is the Option Price?

The option price is the price you have to pay to exercise the option. The price can be fixed and predetermined. Alternatively, the price can be based on the company’s earnings or other forward-looking parameters, if applicable.

What Are the Benefits of an Options Contract?

Option agreements can provide business owners with a powerful tool to motivate, retain, and reward employees. In this sense, an option agreement is often part of an incentive program. By offering ownership in the company, employees can become more invested in the company’s results.

Additionally, option agreements can be a profitable form of compensation, helping to attract and retain key employees, especially in startups and smaller businesses with budget constraints. It encourages long-term commitment, as vesting periods require employees to stay with the company to fully benefit from the options. When the interests of employees align with the success of the company, their efforts are directed towards creating growth and value.

Option agreements can be complex to navigate, but with the right knowledge and advice, they can provide significant benefits.