Legal Definitions - option agreement

An option agreement in a corporate setting is a contract that grants a company or its existing shareholders the exclusive right, but not the obligation, to purchase shares from a specific shareholder. This right is typically triggered by a predefined event, and if exercised, the shareholder is then obligated to sell their shares at a price that was agreed upon in advance. Essentially, it's a mechanism to control who owns shares in a company and under what circumstances, ensuring stability or specific ownership structures.

• Example 1: Departing Founder's Shares

  Imagine a startup where one of the co-founders decides to leave the company to pursue a different venture. Their initial shareholder agreement included an option agreement. When the founder resigns (the specified event), the company has the right to buy back their shares at a predetermined price. The departing founder is committed to selling those shares if the company chooses to exercise this right. This prevents a former founder from holding onto shares in a company they are no longer actively involved with, and potentially selling them to an outside party without the company's control.

• Example 2: Key Employee Termination

  A growing tech company grants a significant number of shares to a crucial software architect as part of their compensation package, but these shares are subject to an option agreement. If the architect is later terminated for cause due to poor performance (the specified event), the company has the option to repurchase their shares at a nominal or predetermined price. The architect, having signed the agreement, is obligated to sell if the company exercises this option. This protects the company from having former employees, especially those terminated for performance issues, retain significant ownership and influence.

• Example 3: Shareholder Retirement in a Family Business

  Consider a closely held family business where ownership is intended to remain within the family. An option agreement is put in place for when a family member shareholder retires. Upon the retirement of a family member (the specified event), the remaining family shareholders have the option to buy out the retiring member's shares at a pre-agreed valuation. The retiring shareholder is committed to selling if the option is exercised. This ensures that ownership remains within the family and provides a structured exit for retiring members without forcing the remaining owners to buy if they don't wish to or can't afford it at that specific moment.