Overview of an Option Agreement
What is an Option Agreement?
An Option Agreement is a contract by which a company gives a buyer an option to buy new shares in the future.
An Option Agreement specifies the type and number of shares to be issued to the buyer, the exercise period, the exercise price, and any condition to be fulfilled before it can be exercised.
Under an Option Agreement, shares are issued to the purchaser when they exercise the option and pay the exercise price. This is also known as “forward vesting”, which is contrary to “reverse vesting” under a Share Vesting Agreement.
What is an Option?
An “option” is a right (but not an obligation) to buy shares at a future date at a predetermined price.
Under an Option Agreement, the buyer does not receive any shares until the option is exercised. This mechanism is commonly known as “forward vesting”, as opposed to giving shares to the buyer upfront subject to the company’s right to buy back under a Share Vesting Agreement, which is known as “reverse vesting”.
The Option Agreement is for a “single grant”, i.e., the company is giving this option to this specific buyer on these specific terms. If you intend to give options to a number of your employees or persons who provide services to you, you should use a Share Option Plan instead.
What are the components of an Option Agreement?
These are the various components of an option agreement.
Option Shares: Shares that will be issued to the buyer when the option is exercised. you can choose to input a fixed number of shares or a percentage i.e. when new shares are issued, what percent will these shares represent in the then entire issued share capital of the company? You should note that this “total issued share capital” is calculated on a fully diluted basis, i.e., all outstanding convertible instruments, notes, and warrants are assumed to be fully converted.
Exercise Period: The period during which the option can be exercised. You can also add conditions to the exercise of an option, i.e., those conditions that need to be fulfilled before the option can be exercised along with the condition to achieve funding of a target amount (called a “Target Funding” in the document).
Option Purchase Price: This is the price to be paid by the buyer for this option. It is different from “exercise price”. This price should be paid at the same time as the Option Agreement is signed.
Exercise Price: This is the price per share to be paid when the option is exercised. the exercise price can be either a fixed amount or a price that is determined by dividing an agreed valuation by the number of issued shares in the company.
Conclusion
An Option Agreement is a legal contract between two parties for buying and selling the shares at a pre-specified price on a particular date. An option agreement can be done for buying and selling of shares, land, or any other types of asset.
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