[Startup Must-Know Laws] The Risks of Put Options in Investment Agreements

A column by attorney Ahn Heecheol of DLG Law Firm

One provision founders should pay particular attention to in startup investment agreements is the share purchase claim right, or put option. If an event specified in the agreement occurs, this right allows an investor to require the company, a founder, or another interested party to purchase all or part of the shares the investor holds. Common grounds for exercising the right include false representations and warranties, use of the investment funds for purposes other than those specified, and breaches of material contractual obligations.

The problem is that this can have a substantial impact on interested parties, particularly founders. When an investor exercises a put option, the shares generally must be purchased for an amount equal to the original investment plus a certain rate of return. A founder may end up having to buy shares worth tens of billions of won all at once when the business is struggling.

However, the fact that an investor has exercised a put option against the company does not mean the company must always buy the shares. When a company purchases an investor's shares, this constitutes an acquisition of treasury shares under the Commercial Act. Article 341 of the Act permits companies to acquire treasury shares, but generally limits the purchase price to the amount of distributable profits. Many early-stage and growth-stage startups have no distributable profits due to accumulated deficits and other factors, making it difficult in many cases to actually purchase the shares even if the agreement states that "the company must purchase the investor's shares."

For this reason, in practice, agreements generally provide that a put option may be exercised not only against the company but also against interested parties, such as founders or major shareholders. If the company cannot purchase the shares, the founder is required to buy the investor's stake personally. This may pose an even greater risk for founders, since a breach of contract by the company could immediately trigger the founder's personal obligation to purchase the shares. The interested party's liability should therefore be structured separately from the company's liability. It would be excessive to hold a founder personally liable for an ordinary business failure or the outcome of a normal business decision. It is reasonable to focus on cases involving actual fault on the founder's part, such as misappropriation of investment funds or the provision of false information, and to limit the obligation to purchase shares to cases involving the interested party's willful misconduct or gross negligence.

A put option is a useful safeguard for investors seeking to recover their investment, but for companies and founders, it can become one of the most onerous liabilities under an investment agreement. It is important to carefully review the circumstances in which the right may be triggered, who is liable—the company or the founder—how the purchase price is calculated, and the degree of fault required of the founder. The significance of an investment agreement becomes clearer when a company is struggling than when it is doing well. That is why a put option should never be taken lightly.

This content was produced with the assistance of AI translation services.