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By Neha Agarwal August 28, 2016


An options clause in the Share Holders’ Agreement- which defines the rights and obligations of the shareholders- is the one in which the investor has the option to either ‘call’ or ‘put’ the equities on the table. This compels the founders’ to sell or buy the equities respectively at a pre-determined rate.

Such options can be exercised at the occurrence of specific events like failure to undertake an Initial Public Offering (IPO) or other default events or after a specific time period.

What is a Put option?

Under Put options, the investors have the right to ‘put’ the shares on the table and the promoters have the obligation to buy the shares at fair valuation of shares or at specified internal rate of return (IRR). For example if the IRR is 25% as stated in the Share holders’ Agreement then the promoters or the founders have to buy the shares at this rate.

Since investor will insist on a high IRR, promoters must ensure that a reasonable IRR should be agreed upon. A high IRR creates a huge financial burden on the promoters and can lead to personal bankruptcy. An option to exit at fair valuation price should be given to the investors instead of minimal IRR or whichever is lower. This right is an exit mechanism for the investors in circumstances when the business is not performing as expected or is performing very badly.

What is a call option?

Similarly, under call option the investor gets the right to ‘call’ the shares of the promoters on the table and purchase them at a specified price on the happening of a certain event. The promoters are obliged to do so. For example, if it is specified that in case of increase in the Foreign Direct Investment cap X will have the option to buy n shares at a specified price from the founders then X cannot be denied of such right. This right ensures that in certain circumstances the defaulting party exits the business.

Legal Validity

Put options on shares of a private company will be legal if granted to an Indian investor. However, if the investor is a foreigner or a non- resident then a minimum guarantee of exit price is in contravention to the RBI guidelines.

There is a lock-in period of one year or a minimum lock in period (which can be three years in certain sectors like defence, construction development) as described under the FDI policy, whichever is higher. The pricing guidelines should also be followed as released by RBI through notifications.

Some points of caution: While drafting options clause, certain important things should be kept in mind such as – the specific amount or percentage of shares subject to put or call options. Questions like - Whether the right can also be exercised in favour of third parties or not? What is the manner in which such options will be exercised? –should be answered clearly. And most importantly, the current legal position on the matter should be kept in mind.

Tags: put and call option , shareholders agreement , put option , call option , india , contract

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