Issuance of ordinary shares on exercise: Overview, definition, and example
What is the issuance of ordinary shares on exercise?
The issuance of ordinary shares on exercise refers to the process by which a company issues new ordinary shares to an individual or entity when they exercise their right to buy shares under a stock option, warrant, or convertible security. These rights are typically granted to employees, investors, or other stakeholders. When the option holder chooses to exercise their right to buy shares, the company issues new shares, which increases the total number of outstanding shares. The issuance of ordinary shares dilutes the existing shareholders' ownership percentage, but it also provides the company with capital that can be used for various business purposes.
Why is the issuance of ordinary shares on exercise important?
The issuance of ordinary shares on exercise is important because it allows companies to raise capital without immediately relying on traditional financing methods like loans or issuing bonds. It also gives employees, investors, or stakeholders an opportunity to participate in the company’s growth and benefit from its success by purchasing shares at a potentially lower price than the market value. However, it’s crucial for companies to manage the impact of issuing new shares carefully, as this can dilute existing shareholders' equity and affect stock prices.
Understanding the issuance of ordinary shares on exercise through an example
For example, a company grants stock options to its employees, giving them the right to buy shares at $10 each over a five-year period. After three years, the employee exercises their stock option and purchases 1,000 shares for $10 each. The company then issues 1,000 new ordinary shares to the employee. As a result, the employee now owns shares in the company at a favorable price, and the company raises $10,000 from the transaction. However, the issuance of these shares increases the total number of shares outstanding, which may dilute the ownership of existing shareholders.
In another example, a startup has issued warrants to its investors, allowing them to purchase ordinary shares at $5 each. After the startup’s valuation increases and the market price of its shares rises to $20, the investors exercise their warrants to purchase shares at the lower price of $5. The company then issues the newly exercised shares, raising capital while benefiting from the investors’ commitment to the company. The shareholders’ proportional ownership is diluted as new shares are issued, but the company gains additional funding for expansion.
An example of an issuance of ordinary shares on exercise clause
Here’s how an "issuance of ordinary shares on exercise" clause might appear in an agreement:
“Upon the exercise of any options, warrants, or convertible securities, the Company shall issue new ordinary shares to the holder of such securities at the exercise price, as specified in the relevant agreement. The issuance of such shares will result in an increase in the total number of outstanding shares, and the Company will record the transaction accordingly.”
Conclusion
The issuance of ordinary shares on exercise is a key mechanism that companies use to raise capital, incentivize employees, and allow investors to participate in a company’s growth. While it provides important financial benefits, it also results in dilution of existing shareholders’ ownership. Companies must carefully manage the process of issuing new shares to balance the advantages of capital raised with the potential impact on shareholder equity.
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.