The Benefits of a Solid Put/Call Option as Part of a Shareholders’ Agreement | Canada

A great many parties – especially first-time shareholders – will join a shareholding group or company with a utopian mindset wherein everyone gets along amicably, and any changes take place with calm and kindly accordance. However, once reality sets in, and the differing situations, needs and personalities of the various shareholders become apparent, things can change drastically.

While they can sometimes be difficult conversations to have – especially during the initial “honeymoon” phases of joining a shareholding group – discussing and establishing put/call options early on, at the start of shareholders’ agreement negotiations, can provide all shareholders with peace of mind that the majority of future disagreements or exchanges have been anticipated, and covered contractually, during more amenable and less fraught times and conditions.

Put and call options can at first seem something of a complicated set of concepts. In whatever context you are approaching them, put and call options provide the buyers or sellers of specific assets (such as shares, stock, commodities, or any other form of asset or instrument) with the right (but not the obligation) to buy or sell those assets for a predetermined price, which may include a premium or discount. Put and call options will – in many instances – provide certainty and protection against losing more than has been agreed between the parties. The options have historically been used in public market securities, but recently have been considered in shareholders’ agreement, as an added level of comfort for one or more parties and a functional tool to resolve potential partnership disputes that may arise. This article will focus on the benefits that put and call options – when done well – can give you in the context of a company’s shares.

In simple terms, put options give the option holder the right (but not the obligation) to sell their shares to another party (usually the company or other shareholders) at a specified price. A put option can be triggered by the option holder/shareholder at any point, such as: the shareholder wishing to exit the company; a breach of the shareholders’ agreement; or simply a breakdown in the shareholders’ relationships. Essentially, a put option gives the option holder – for a premium – the right to “put up for sale” the specified amount of shares. Given that the timing of the put is controlled by the exiting shareholder, a discount is used to ensure that the shareholder truly contemplates the exit and is rewarded for this decision.

Call options, on the other hand, give the option holder/shareholder the right (but, again, not the obligation) to buy a specific, additional amount of shares held by other shareholders at a predetermined price, for a premium. In other words, the option holder has the right to “call the stock away” from the seller. Also, as with a put option, a call option can be exercised by the shareholder if certain triggering conditions occur. The call option includes a premium since the shareholder exercising this option is forcing someone to exit at a time that they may not wish to.

Without put/call options in place, parties can be faced with tricky and sometimes fraught negotiations in the event that a shareholder wishes to buy or sell shares from other shareholders. Many shareholder agreements often involve “shotgun” provisions or clauses (also known as buy-sell agreements) as a means to trigger a sale, or to resolve disputes or disagreements among shareholders. One of the biggest problems with these provisions is that – in many scenarios – it is the party calling “shotgun” and initiating a buy-sell agreement that loses the negotiating power, often resulting in a deadlock in shareholders who wish to buy or sell their shares, but not lose control of any negotiations. However, a strong set of put/call options, built into your shareholders’ agreement, can provide all shareholders with a clear, pre-agreed path to resolving any such problems before they even begin.

But most importantly: a good set of put/call options frequently means that any exchanges between shareholders are less costly (both financially and emotionally) than without them.

Going hand in hand with the above, building solid put/call options into a shareholders’ agreement early on means having frank negotiations with fellow shareholders and establishing a common ground from which to take things forward, should any party wish to buy or sell in future. Part of this involves determining what price will be used to trigger the put/call options (typically referred to in derivatives circles as the “strike price”). The strike price is something that each company or shareholder group determines for itself – be it based on metrics like EBITDA (earnings before interest, taxes, depreciation and amortisation), adjusted EBITDA, those provided by GAAP (generally accepted accounting principles), or any other form of evaluation.

Whatever the price used, it is generally whatever the shareholders have agreed to be “fair market value”, and is something that all shareholders must have reached a consensus on beforehand. Developing a good set of put/call options means that you can have these tough conversations without needing to consider other, more contentious routes further down the line.

Whether or not you decide to pay for options as part of your shareholder agreement is largely down to individual preference. Are you comfortable with a degree of uncertainty or vulnerability? Then options may not be worth the premium for you. Do you prefer to have your position protected contractually, and any outcomes or losses certain? Then put/call options are the way to go.

Whatever you decide to do, as a shareholder, you should always ask yourself the right kinds of questions regarding the risks you are willing to take, and how much trust you are willing to place in your fellow shareholders. The road might be paved with good intentions, but solid put/call options can help ensure that the destination at the end of it is not an unexpected one.