Buying and selling shares is a great way for business owners and individuals to capitalise on a company’s growth and success. There are different kinds of shares which operate and function in different ways. One such type is known as an ‘option’ or share option.
Share options are not shares in the traditional sense, but they can become shares if and when the option to exercise the right to buy or sell the shares arises. Below, we answer some frequently asked questions about share options.
1. What is a Share Option?
A share option is an arrangement whereby the company grants the option holder the right, but not the obligation, to buy or sell shares in the business. The right to buy shares in a company is referred to as a ‘call option’, and the right to sell shares in a company is a ‘put option’.
There are various strategic and commercial reasons for parties to enter into share option arrangements, for example:
- providing financial incentives for investors; or
- performance incentives for shareholders who are active in the operations of the company’s business.
2. Who is the Option Holder?
The person who grants the option, or grantee, is often referred to as the ‘option holder’. The right to exercise the share option always resides with the option holder. This is the case for both call options and put options.
For call options, it is likely that the company and existing shareholders will need to provide additional approvals before a prospective member enters into a share option arrangement. Under a share option, the option holder only has a right to acquire or sell shares. The ownership of the shares does not pass to the new owner until after the option holder has exercised the option under the terms of the share sale agreement.
3. Who is the Grantor of the Option?
In the case of a call option, the grantor will be either:
- the company (if the call option is for the subscription of new shares); or
- an existing shareholder (if the call option is for the purchase of existing shares in the company from an existing shareholder).
In the case of a put option, the grantor will typically be an existing shareholder.
4. What are the Option Shares?
The option shares are the shares in the company which are subject to the share option:
- In the case of a call option to subscribe for shares, the company is yet to issue ‘option shares’. For example, if a company has a total share capital of 100 shares and grants a call option to issue an additional ten shares, the ‘option shares’ will be those additional ten shares (even though the company will not issue those shares until after the option holder exercises the call option).
- In the case of a call option to purchase shares, the ‘option shares’ may be over all or part of the shares the grantor holds. For example, an existing shareholder may hold a total of 50 shares but only grant a call option over 20 shares.
The share option agreement will set out the number of option shares and the price of those option shares when the option is exercised. The price of the option shares (also referred to as the ‘exercise price’ or the ‘strike price’) is usually cash consideration. However, there may be no cash price if the share options are to be issued or transferred based on performance or other non-cash consideration.
5. When Can the Option Holder Exercise the Share Options?
The option holder will have a specified period in which they can exercise their share options. Parties will agree to this period which is then set out in the share option agreement. Depending on the commercial arrangements between the parties, the structure can be such that the option holder can exercise the option at any time, or upon fulfilment of specified conditions (e.g. if the option holder achieves pre-agreed performance milestones).
Other Key Considerations
It’s important that the constitution of the company and the terms of any existing shareholder arrangements are reviewed and complied with before parties enter into any shareholder agreement. Usually, there will be pre-emptive rights over shares in the company, and requisite approvals may need to be obtained before proceeding. Some companies will require either a board resolution and/or shareholders’ resolution to pass before the company can issue a share option or enter into an arrangement involving options.
The company’s shareholders agreement (if such an agreement exists), will bind any new shareholder following the exercise of their share options. When entering into such arrangements, it is imperative that all stakeholders are aware of the proposed share option agreement and its implications going forward.
If you have purchased a share option, or have given someone a share option in your company, you must educate yourself as to the way that share options work. Consider when you can or will exercise the option and what value the option has, and ensure these are written down in a binding agreement.
If you have any questions about share options or need assistance drafting a share option agreement, get in touch with our commercial lawyers on 1300 544 755.
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