A call option agreement is where the grantor gives the grantee (also referred to as the ‘option holder’) the right, but not the obligation, to buy shares in a company. The option is usually over a pre-determined number of shares at a specified price (sometimes referred to as the ‘exercise’ or ‘strike’ price). If the option holder doesn’t exercise their right during a given period, the option (and the rights that attach) expire. Below, we set out the key terms a call option agreement typically includes between the grantee and the grantor.
1. Parties to the Agreement
The company may grant the call option for the issue of new shares or a shareholder for the transfer of existing shares. A grantee (option holder) and grantor (the company or existing shareholder) are parties to the option agreement. The grantee may be an individual or corporate entity.
2. Option Shares
The shares in a company that are subject to the call option agreement are referred to as the ‘option shares’. Option shares may be either:
- new shares that the company is yet to issue (in the case of a call option to subscribe for shares); or
- old shares an existing shareholder is transferring to the option holder (in the case of a call option to purchase shares).
The agreement should clearly define the scope of the call option arrangement (for example, the agreement should set out the exact number of option shares).
3. Option Premium
The option premium is the amount paid for the call option itself. Usually, this will be for a nominal amount since the option holder is typically required to pay the exercise price for the shares at the point of the exercise. The option premium is different to the exercise price (discussed in further detail below). If an option premium is required, it will be paid to the grantor of the option when the agreement is established. An option premium is not always provided for in a call option agreement, and whether one should be included depends on the commercial terms of the arrangement.
4. Exercise Price
The exercise price is the price payable for the option shares after the option holder has exercised the call option. This price is usually a pre-determined amount and set out in the call option agreement as a fixed price per share. The option holder pays the exercise price to the grantor of the option upon completion of the issue or transfer of shares (as the case may be). In certain circumstances, there may be no exercise price because the option holder may need to achieve certain performance milestones as consideration.
5. Effective Date
As the name implies, the effective date is when the call option becomes effective. This may be the day the grantee signs the call option agreement of another pre-determined date in the future. The effective date should not be confused with the exercise date (i.e. the date on which the option holder exercises the call option).
6. Conditions to Exercise
Often, the exercise of a call option will be conditional upon certain events occurring. For example, the option holder may only be eligible to exercise the call option after a fixed period or after it has satisfied pre-agreed performance milestones. While the grantor’s commercial objectives usually determine these conditions, they are not necessary. A call option can be structured so that the option holder can exercise the call option at any time.
7. Expiry Date
The expiry date is the last day of the option period, that is, the period in which the option holder may exercise the call option. Usually, the call option agreement will terminate on the expiry date. The call option agreement can also be structured so that it terminates upon the occurrence of other special circumstances as determined by the parties.
8. Full or Partial Exercise
A call option may be structured so that it is either fully or partially exercised. A fully exercised call option means that the option holder must subscribe or purchase all the option shares under the agreement upon exercise of the call option. For a grantor, this method creates more certainty.
For a partial option, parties typically agree on a minimum number of options that the option holder must exercise. The option holder has the right to exercise the call option until all the option shares have been subscribed for or acquired, or until the option period expires.
Before executing a call option agreement, parties must consider other company documents to determine whether additional approvals are required.
For instance, the shareholders’ agreement (if one exists) may contain pre-emptive rights over the issuance of shares or the transfer of shares in the company, and existing shareholders will need to waive those rights. The company constitution may also restrict the issuance of shares to new shareholders.
A call option agreement will usually contain standard representations from each party that the execution and performance of the agreement does not contravene either:
- the company constitution;
- any agreement that the party is part of;
- any applicable law.
It is, therefore, important that all approvals are taken into account when considering entry into a call option agreement.
Before entering into a call option agreement, ensure you are familiar with the concept of option shares, how they work and when you can exercise a right to buy or sell them. You should also consult any shareholders’ agreement or other agreements that may impact your ability to enter into a call option agreement.