Repurchase Option: Everything You Need to Know
A repurchase option is a term used when a company originally issues stock shares.3 min read updated on February 01, 2023
Updated July 14, 2020:
A repurchase option is a term used when a company originally issues stock shares. It allows the company to repurchase the shares from the shareholders who own them at a later date. A repurchase option may be used for a number of reasons by a company. Some of the results that can occur from this type of arrangement include:
- Providing liquidity to the departed
- Permitting the surviving to retain all of the ownership
- Preventing those who are less desirable from being shareholders in the company
Some stockholders may wish to have a repurchase option be mandatory in the event of disability or death because they might see a need for possible liquidity. They also may want there to be the optional right in the event the company is sold to a third party. This way, the company may not be forced to make a payment it can't afford but still has security to prevent the risk of being sold to a competitor.
Repurchase rights are often utilized by startup companies that may wish to issue what is referred to as common stock, which is issued to the founders of a business when it is formed. When a repurchase right is offered, there is often a structure in place that allows the repurchase to occur only during a preset time period.
Differences Between a Repurchase Right and Vesting
There are many differences between a standard repurchase right and vesting.
- With a repurchase right, a shareholder owns the stock that is subject to repurchase. When stock options are vested, the option holders do not have any rights to the stock.
- A repurchase right gives the originating company the right to buy back the sold stock from the shareholders if certain conditions are met. The company does not have to exercise the right, and if it doesn't, the shareholder retains the rights to the stock.
- When the options are subject to vesting, the company will not have to take an action if the employee is fired or chooses to leave the company. These options revert back to the company automatically.
- When you have a repurchase option, the stocks are typically sold back at the price they were purchased at. In some cases, the value may be tied to what the current shares are valued at on the market.
What Happens When Repurchase Rights Are Exercised?
Under many repurchase right agreements, the right to repurchase can fall to multiple parties. This usually occurs in a waterfall-type structure. The company retains the right of first refusal to repurchase the shares, but if it exercises this right, it will next shift to other investors in the company. If parties with the right to repurchase option choose to repurchase, then the shareholder will keep their shares.
There are many situations where both the investors and the company will allow the repurchase right to expire, especially if the company is doing well. An example of this could be when a founder is asked to step down from the role of CEO, but it is done on an amicable basis.
A repurchase right decision is often made by the board of directors, though it might be done by a voting agreement or other procedure the company has set forth. There can be conflicts of interest for the board to consider in the event of a repurchase option. The shareholder who is leaving may have a board seat, which would make them one of the decision-makers when it comes to the repurchase right option.
Equity Reallocation Without an Agreement
If there is no agreement in place for how repurchase rights will be handled by the company, then there may need to be a negotiation or the company may need to find a way to dilute a nonperforming or departing founder. Negotiated results are often not in the best interest of the company, so it is beneficial to have an agreement in place. If there is no agreement, the company should retain a lawyer to determine the best course of action and explain why exercising the repurchase right is the best decision.
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