What is an Option Agreement?
As a legal agreement between two parties, an option agreement is a legally binding agreement. Generally speaking, it acts as a kind of guarantee to the buyer of a certain ‘option’ in the subsequent sale of the property. The seller guarantees not to sell or rent out the property to any other party or person during the duration of the option agreement. Instead, they promise to take the home off the market for the agreed specified period. Either the buyer or the seller can specify on the contract what the period will be to avoid any uncertainty. Most often, the period specified here will be around six months .
The option agreement is valid on the understanding that the buyer pays the seller a small fee for this option as a kind of incentive. This is known as a ‘fee’. It must be listed on the agreement and is non-refundable. Often, it is 10% of the total price of the house. So, for example, if the property was worth £100,000 and there was a 3-month option period, then the fee would be £1,000. In addition to this, the buyer also usually pays the seller a small nominal consideration (e.g. £1). This consideration must be listed on the contract as being provided by the buyer for the agreement to be legal and binding to avoid confusion.
Essential Elements of an Option Agreement Template
An option agreement template is a fundamental part of real estate transactions. It should be prepared with care and should be based on the relevant precedent from other such agreements, but must be tailored to the specifics of the current transaction. A good option agreement template should include:
Parties. The parties to an option agreement template are the optionor (the person granting the option) and the optionee (the person receiving the option). Both parties should be clearly identified in the contract to avoid any confusion as to who is who.
Option term. An option agreement template should include a clear start date and ending date for the option granted through the agreement. The date should also be in accordance with the stipulations within the rest of the contract. This section should also include stipulations for who the agreement can be assigned to.
Exercise price. The exercise price is the price set by both parties which allows the optionee to purchase the property at the end of the option term. The exercise price should be set according to the standards of the rest of the contract. In the event of an assignment of the option by the optionee, the option agreement template should also be clear whether the assignee will still have the same option price or whether the option price must also be negotiated then.
Any additional conditions. The option agreement template should detail any other conditions to the option that may be relevant to that specific case, so both parties can determine if the option will be right for them. These include things like how the property will be used or how many years the agreement will last.
Advantages of an Option Agreement Template
Efficiency is a prime consideration for those who do business. It might be holding costs down in the educational classroom, designing workflow procedures for an accounting department, or even establishing a benefits structure for a company. Whatever the situation may be, efficiency saves time and money.
When it comes to the real estate market in the United States, options contracts (or option agreements) are everywhere, so the ability to conventionally prepare them is a necessary element of a real estate professional’s job. For brokers, an option agreement template can provide the uniformity and efficiencies to help you do this.
One of the main reasons for using a template is to save time. When a real estate professional is capable of utilizing option agreement software, searching online for a template, or using their own template, they will not have to spend time developing one from scratch. They can simply fill out the information needed, print it, and send it off. That saves time that can be used elsewhere to help find other lots or to make successful sales.
Cost savings is another reason to use an option agreement template. When you are required to create option agreements regularly and must have attorneys examine them, using a template from a legal professional saves some legal fees because the attorney can easily review it, rather than consider new language or structural changes to a unique document. So it can save you the cost of attorney review fees.
Using an option agreement template can also help build consistency into contracts where there are multiple "like" contracts being prepared. Again, this provides for greater efficiency in legal review and gives everyone the same agreement, which simplifies the communication process.
An option agreement template can also provide consistency when identifying parties to a contract. When you have to use the same parties over and over again, you do not want the incorrect party listed on the document. It becomes problematic if the incorrect entity is listed as the buyer or seller because that could result in endless legal battles to determine if the right party can engage in the purchase or sale.
Option Agreement Template Editing
A tailor-made option agreement template will often be much quicker to work with than a one-size-fits-all agreement. Even so, properly customizing an option agreement template for any given business transaction can sometimes feel like performing brain surgery. Here are some steps and guidelines that can often help you successfully engage in the process.
First, read the option agreement template to get a basic grasp of its structure. What clauses does it have? How is it organized? What type of information is it soliciting?
Second, make a list of any special clauses or terms necessary for your particular transaction. Note specific conditions for making selections and filling in the blanks in the language of the option agreement template. Think carefully about the type of parties involved in the transaction and any restrictions that apply to them.
Third, make any required selections from among the templates’ options. Follow this step by filling in the agreement template’s blanks with the necessary information. Try to do so in a way that uses clear, straightforward language that is also consistent with the language used throughout the rest of the option agreement template . Avoid using "fill in the blank" language if at all possible, instead using complete sentences and phrases. This helps the parties to ensure that they correctly understand their rights and responsibilities under the agreement. Make sure that you fill in blanks as completely as possible while not providing any information that isn’t necessary for proper execution of the option agreement template.
Fourth, confirm that the option agreement template clearly communicates all of your needs, demands and wants regarding the agreement and the associated transaction. Are there any alterations to the template that you need to clarify further? Would additional specificity help you? Would a different order of clauses improve the document’s structure? Do you need the option agreement template in hard copy?
Fifth, have an attorney review your final draft of the option agreement template to ensure that it meets both parties’ needs. Doing so helps to avoid any potential misunderstandings, errors and corrections later on.
Finally, allow either side to take as much time as necessary to consider and approve the altered agreement template. After the template receives final approval from all involved parties, print, sign and date the proper number of copies for them.
Legal Considerations and Common Pitfalls
There are many legal considerations to bear in mind when drafting or signing an option agreement, including:
• What happens if the business is sold, new owners come on board, new management takes over, etc.?
• What is the vesting schedule?
• When vesting is complete, what is the employee buying? Is it stock or membership units?
• When does the individual take ownership of the stock units, which is a question of stock rights vs. stock ownership.
• Is there a cliff (probation)?
• Is there an incentive to stay on as an employee? Does the individual get a return on investment if they decide to leave?
• Is it convertible at the full fair market value?
• Is there a redemption obligation?
• What happens to the stock if either the employee or the founder/manager leaves?
• What value is the company willing to buy back the stock for?
• Under what terms can the individual sell their shares of the company?
Common pitfalls incorporate these issues into the option agreement too late, without thoroughly contemplating the consequences. For example, when a business is sold, the individual’s stock could be worth anything from nothing to 100% of the company. You want to withdraw your right to acquire, when you sell, but you also want to protect your interests and gain some benefit from the sale.
Some businesses do not do this because they believe that the individual will never leave. But by thinking ahead, you can structure an exit strategy that works for all, including the individual.
If you are giving stock to someone, consider what happens to it if you hire someone else and that person becomes the individual’s boss.
There are many legal considerations that go into a stock option agreement and carefully structuring the right one will allow you to make the most of your business’s potential.
Option Agreements FAQ
How may many times can the option be granted to same individual or entity?
Again, there is no set or standard number of options that may be granted to one individual, business or investor. For example, should an investor desire to purchase 1,000 shares per month under option agreements of 2,000 shares each, they may enter into multiple option agreements with the same parameters with that company 12 times a year.
Does the option agreement require a purchase price fair to both parties?
An option agreement does not require a purchase price fair to the company and its prospective buyer. The price can be vastly different from what the company anticipates to negotiate a purchase agreement for the same shares at a much higher price. The intent and benefit of an option agreement is to allow the prospective buyer the time to establish a business relationship with the company before it buys in at a price significantly higher than what it has paid under the options.
May a fee be charged for the option agreement?
For the seller, the fee could be based on the investment from the buyer or the number of shares it wishes to purchase . Investment banks and advisors, venture capitalists or angel investors may require such fees if they are part of a directive plan within the transaction. However, it is not required that a fee be charged.
Who else may benefit under the option agreement?
The option agreement can provide the issuer or company the right to assign the option or actual share purchase agreement to another individual or entity. This could be a family member, business partner, corporate partner, executive or entity it has a service agreement with that will allow that entity a predetermined amount of shares under the same terms and conditions of the initial sale to the investor. The issuer may not necessarily want the individual they contracted with to be the only entity to enter into a purchase agreement.
May an option agreement expire?
An option agreement may expire before the investment is complete. The expiration is arbitrary, typically 30-90 days, or even longer, or otherwise specified as an event, such as the consummation of a transaction. Should that occur, the option and any shares designated under that option would be forfeited.