By: Adrian Lopez Casab
In the Mexican market, shareholder/partner agreements have been gaining importance as a mean to regulate the relationships among investors, founders and, in general, with the other partners of a company, regardless of their motivation to acquire such status. In this context, put and call clauses are legal instruments for shareholders to anticipate mechanisms to control the transfer of shares and provide their investors with flexibility for entry and exit as shareholders of a company.
A call option or call is a clause by which one party acquires the right, but not the obligation, to acquire assets or shares from one or more transferring parties, at a determined or determinable price, and those transferring parties are bound to transfer said assets or shares in case the acquiring party exercises its right. This clause is attractive, for example, for investors seeking to consolidate control in a company, to invest in stages based on results, or to founders seeking to maintain buy-back options over shares acquired by external investors.
Conversely, a put option or put is a clause that grants its holder the right, but not the obligation, to sell assets or shares to the counterparty, at a determined or determinable price, and the counterparty is bound to acquire such assets or shares in case the selling party exercises its right. This clause is commonly used in the context of joint ventures to govern the exit of one of the parties, or in private equity or venture capital investments in assets or shares where typical exit routes, such as a secondary sale and an initial public offering (IPO), are not available because a fully developed is non-existent.
In the drafting of these types of clauses, there are two critical aspects that must be considered (without prejudice of the possible existence of other relevant considerations for their drafting that should be assessed on a case-by-case basis). The first is the period within which the right may be exercised or the events that may trigger its exercise should occur, and the second is the price for the acquisition or sale of the shares or assets.
Although there is no specific regulation governing the term of validity of put and call clauses, it is customary for such clauses to include an exercise period, or, if no period is specified, to provide for the right to become enforceable upon the taking effect of certain event or the concurrence of certain assumptions which should be provided for in the clause itself. Some events commonly agreed as triggers for the right to exercise these clauses include, without limitation, the fulfillment of operational or financial targets, change-of-control events, the exit of a key founder, material adverse changes to the business or an irreconcilable disagreement between the parties (deadlocks).
The other crucial element to consider in connection with these clauses is the mechanism for determining the valuation or price of the assets or shares subject to the clause. Among others, common options for determining the value of the assets or shares include: (i) a financial valuation mechanism (such as multiples of EBITDA or sales); (ii) valuations carried out under pre-established procedures by an independent third party, preferably identified and approved in advance by both parties; or (iii) the average of several valuations or formulas that consider elements such as the risk at the time of making the investment and expected future valuations, among other aspects. For the protection of the parties and to avoid uncertain and potentially volatile valuations upwards or downwards (as it often occurs in venture capital), it is possible for these valuation mechanisms to include guaranteed minimums (floors) and/or maximums (caps) for the price.
Put and call clauses, if properly structured, provide highly valuable instruments to promote investment in private companies and to protect the interests of their shareholders/partners; they also create a mechanism by which a person can increase or liquidate their stake in the company upon the occurrence of certain events. Due to their sophistication and the various elements that must be considered for their implementation, these clauses should be analyzed in depth on a case-by-case basis and drafted with the greatest possible precision.
