Put and call options in shareholder agreements - are they necessary and if so when and what to include?

Put and call options can provide crucial exit mechanisms in private company shareholder agreements, giving shareholders either the right to force a sale of their shares (put option) or to force another shareholder to sell to them (call option).

While these mechanisms can be valuable tools for managing shareholder exits, their suitability varies significantly depending on the type of company, its shareholders, and its commercial context. Understanding when these options work best - and when they might create more problems than they solve - is crucial for companies considering including them in their shareholder arrangements.

Situations where put options are important in a shareholders agreement

• Death/critical illness of shareholder - ensures family members can realise value after death or when shareholder becomes seriously ill. Provides certainty of exit and prevents unwanted family involvement in business.

• Retirement at specified age - allows older shareholders to realise investment at predetermined age. Often linked to ongoing consultancy or handover arrangements.

• Significant dispute/deadlock - provides exit mechanism when shareholders can't agree on fundamental issues. Usually requires formal deadlock process first.

• After minimum holding period - gives investors guaranteed exit after specific time period. Common in private equity or venture capital investments to ensure liquidity.

• Employment termination - allows employee shareholders to exit when they leave employment. Often linked to good/bad leaver provisions affecting valuation.

• Change in business direction - enables minority shareholders to exit if company significantly changes its business. Protects against fundamental changes they didn't sign up for.

• Personal bankruptcy - forces exit when shareholder faces personal financial difficulties. Protects company from creditor involvement.

• Loss of professional qualifications - important in professional service firms where qualification is essential. Ensures exit if shareholder can no longer practice.

Situations where call options are important in a shareholders agreement

• Breach of shareholder agreement - allows company/other shareholders to remove shareholder who breaches agreement. Often at discounted valuation as penalty.

• Competition with business - enables removal of shareholder who starts competing business. Protects company from conflict of interest.

• Employment termination - forces exit when employment ends, particularly in bad leaver scenarios. Maintains link between employment and share ownership.

• Bad leaver situations - allows company to require sale following misconduct or other bad leaver events. Usually at lower valuation than good leaver.

• Change in control of corporate shareholder - prevents unwanted third parties gaining indirect control. Particularly important when shareholders are companies.

• Insolvency events - enables removal of insolvent shareholders to prevent creditor involvement. Protects business stability.

• Loss of regulatory approval - important in regulated businesses where shareholder approval is required. Ensures compliance with regulatory requirements.

• Divorce/relationship breakdown - prevents shares being transferred through divorce settlements. Maintains control over shareholder base.

Business types that often have put and call options in a shareholders agreement

Professional Service Firms

• Clear link between employment and shareholding- partnership model means shares automatically need transfer when someone leaves the business

• Usually stable/predictable valuations - often based on recurring revenue or profit multiples that remain relatively consistent

• Regular need for shareholder exits - partners regularly retire or move firms, creating established exit patterns

• Often have cash available for purchases - regular profit distributions mean funding usually available

• Partners understand the mechanism- sophisticated parties familiar with standard exit processes

Joint Ventures

• Clear exit triggers - usually tied to specific events or timeframes that are well-defined from the start

• Sophisticated parties - both sides typically have experience with complex corporate arrangements

• Often pre-agreed valuation methods - parties can agree mechanics upfront when relationship is good

• Usually well-funded parties - corporate partners typically have access to necessary funding

• Professional advisers involved - expert support available for implementing complex mechanisms

Investment Agreements

• Clear investment timeframes - investors typically have defined exit horizons from the start

• Sophisticated investors - understanding of complex exit mechanisms and implications

• Complex valuation mechanisms acceptable - parties comfortable with detailed pricing formulas

• Understanding of tax implications - professional investors factor in tax efficiency

• Often includes ratchets/adjustments - can accommodate performance-based price adjustments

Business types that often have put and call options in a shareholders agreement

Small Owner-Managed Businesses

• May lack funding for purchases - often operate with limited cash reserves and borrowing capacity

• Complex valuations problematic - may lack sophisticated financial information or forecasts

• Less sophisticated understanding - owners may not fully grasp implications of mechanisms

• Cost of implementation high - legal and accounting costs significant relative to business size

• Other mechanisms may work better - simple pre-emption rights often sufficient

High-Growth Companies

• Valuation too volatile - rapid growth makes future value hard to predict

• Future funding needs unclear - may need flexibility for new investment rounds

• Exit preferences may change - business model and exit strategy often evolves

• Complex cap tables - multiple share classes make valuation mechanics difficult

• May prefer drag/tag rights - more suitable for potential trade sale or IPO

Early Stage Companies

• Too many unknowns - business model not yet proven

• Limited cash available - all cash typically needed for growth

• Valuation difficulties - no trading history to base valuations on

• May need flexibility - too early to commit to exit mechanisms

• Cost concerns - legal costs disproportionate to business size

Contact Us

Our team regularly advises on shareholder agreement structures for companies at all stages, from startups to established businesses. We can help you determine whether put and call options - or alternative exit mechanisms - would work best for your specific circumstances.