Cash exercise: Overview, definition, and example
What is a cash exercise?
A cash exercise refers to the process where an individual or business chooses to exercise a financial option (like stock options or warrants) by paying cash instead of using other methods, such as exchanging other assets or shares. In the context of stock options, a cash exercise means purchasing the underlying stock by paying the required price in cash rather than converting or exchanging other securities. This is often done when someone holds options or warrants and decides to buy the underlying asset (such as stock) to take advantage of favorable market conditions.
For example, if an employee has stock options to buy company shares at $10 each, and the stock is currently worth $30 per share, the employee might choose to exercise the option and pay $10 per share in cash to acquire the stock.
Why is a cash exercise important?
A cash exercise is important because it allows the holder of an option or warrant to actually acquire the underlying asset, such as company shares, by paying cash upfront. This is a direct way to make use of financial instruments like stock options or warrants, turning them into actual ownership or value. Cash exercises are commonly used when the price of the asset has risen above the exercise price, making it a profitable move for the holder.
For businesses offering stock options to employees, cash exercises are a way to reward employees with ownership in the company, while also raising capital if the company issues new shares. For employees or investors, a cash exercise provides an opportunity to purchase stock at a discounted price, which can be beneficial for long-term investment.
Understanding cash exercise through an example
Imagine you work for a tech company and were granted stock options to purchase 1,000 shares at $15 per share. The current market price for those shares is $50. If you choose to exercise the options, you would pay $15,000 in cash (1,000 shares x $15 per share) to purchase the shares, even though they are worth $50,000 on the market (1,000 shares x $50 per share). This allows you to make a profit by selling the shares at the market price or holding them for future growth.
In another example, a company might issue warrants to an investor that allow them to buy shares at $20 each. If the company’s stock price rises to $40, the investor may choose to exercise the warrants by paying cash, purchasing the stock at the lower price of $20 per share, and potentially selling it for a profit.
An example of a cash exercise clause
Here’s how a cash exercise clause might appear in an option or warrant agreement:
“The Holder may exercise the Option at any time by paying the Exercise Price of $10 per share in cash to the Company. Upon receipt of the Exercise Price, the Company will issue the corresponding number of shares of Common Stock to the Holder, subject to applicable laws and regulations.”
Conclusion
A cash exercise allows the holder of a financial option or warrant to purchase an underlying asset, such as stock, by paying the required price in cash. It’s an important mechanism for turning options into tangible assets, and it can be a profitable strategy when the asset’s market value exceeds the exercise price. For businesses, cash exercises can help raise funds and provide employees with ownership incentives, while for investors or employees, it offers a chance to benefit from market appreciation.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.