An Option to Purchase (or “Call Option”) is an Option pursuant to which the Purchasers can force the Vendor to sell their Equity in the Business for a Pre-agreed Price and on pre-agreed payment terms.

In effect, a "Call Option" is the reverse of a "Put Option".

Provisions in Business Agreements

Call Options are very common in the Business Succession context.

The standard provisions in a Shareholders Agreement or Partnership Agreement usually include:

A Call Option or Option to Purchase the Outgoing Proprietor’s Equity exercisable by the Purchasers only; and
A requirement that the Purchase Price be determined by a valuation process.

Un-funded Call Options

A standard Call Option gives certainty to the Purchasers, but does not necessarily give certainty to the Vendor.

The Vendor (usually the Deceased Life Insured's Estate) will not know whether a sale will take place or what the Purchase Price will be, unless and until the Purchasers exercise their Call Option.

Usually, the Purchasers will not exercise their Option unless:

they are prepared to pay the required Purchase Price; and
they can fund the Purchase Price (either personally or by way of bank loan).

The second issue effectively makes the exercise of the Option conditional upon the Purchasers having a funding mechanism in place.

What if the Purchasers Don't Exercise the Call Option?

It is difficult for the Purchasers to exercise their Option, until they have determined the Purchase Price and assessed the feasibility of borrowing and paying this amount.

If they don't want to pay the agreed Price or can't afford to borrow or fund it, they would let their Option to Purchase (or Call Option) lapse or fall over.

The parties would then have to haggle over an alternative arrangement.

A Call Option gives the Purchasers certainty (if they want it), in the sense that it allows the Purchasers to fix or "cap" the Price they must pay to the Vendors.

However, it doesn't give the Vendors any certainty, until the Purchasers decide to exercise their Option.

In a sense, a Call Option creates a "Ceiling Price" for the Purchasers (i.e., a maximum Price thay can be asked to pay), but it doesn't create a "Floor Price" for the Vendors (i.e., a minimum Price they will receive).

Put and Call Options

In order to give the Vendors certainty, the parties need a "Put Option".

Proprietors can use a combination of Put and Call Options to achieve certainty for both parties .

Adviser Tip

"Conditions Precedent" and "Put and Call Options" are just methods of legal drafting that postpone the date of disposal of the Equity in the Business from the date of the Business Succession Agreement to after the date of occurrence of the Insured Event.

If correctly drafted, both methods are acceptable to the ATO.

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