Creating Exit Options: Structuring Calls and Puts in SMB Investments

Call and put options aren't just for public market traders — in small and medium-sized business (SMB) acquisitions, these mechanisms play a crucial role in structuring deals between operators and investors. While public market options involve trading standardized contracts, SMB deal options serve a different purpose: They provide both parties a clear path to adjust their ownership stakes as the business evolves.

For operators who want to eventually own 100 percent of their business or investors seeking reliable exit strategies, these options can separate a smooth transition from a messy dispute. Yet many entrepreneurs and investors enter SMB deals without setting expectations for future liquidity.

Understanding call and put options

In SMB acquisitions, call options and put options serve as essential tools for structuring ownership transitions. A company call option gives operators the right to purchase equity back from investors at a predetermined price or formula. Conversely, a put option allows investors to sell their shares back to the company, providing a clear path to liquidity.

It’s important to note that an option gives the holder the right, but not the obligation to exercise. For instance, even if an operator can exercise a call option to buy out investors, she may not want to. She may believe that a better use of capital is to reinvest in growth, acquire a small tuck-in, or pay down debt. On the other hand, despite an investor having the right to get bought out, he may want to remain a shareholder and continue to back the operator.

The options  typically become exercisable after specific milestones. For example, a call option might become exercisable after investors receive a target return on investment, often combined with a minimum timeframe, like 5 to 7 years. This prevents an operator from immediately buying out an investor when times are good, meaning the investor misses out on the upside from a risky investment. 

Put options similarly balance investor protection with business stability, usually including both performance metrics and timing requirements. It’s worth noting that while a call or put option can become exercisable after a certain target return on investment or timeframe alone, it’s more common to see them combined for small business acquisitions.

Both call and put options in SMB deals require careful consideration of valuation methods. Common approaches include using earnings before interest, taxes, depreciation, and amortization (EBITDA) multiples, or bringing in third-party valuation experts. The goal is to establish fair market value that accounts for both the company's growth and investors' expected returns.

Benefits and key considerations 

For operators, company call options provide a path to full ownership without requiring all the capital upfront. This structure allows entrepreneurs to eventually buy out investors as the business generates cash flow while also maintaining control of daily operations. Call options also help operators avoid complex negotiations when they're ready to consolidate ownership.

From the investor side, put options offer protection and flexibility. They create a clear exit mechanism if certain performance targets aren't met or if market conditions change. This is particularly valuable in the SMB space, where traditional exit paths like initial public offerings (IPOs) are not as relevant or strategic sales may be limited.

Despite their advantages, call and put options require careful structuring. For one, the company has to ensure it’ll have sufficient capital available when options become exercisable. This often entails maintaining cash reserves or securing financing commitments. Additionally, both parties need to agree on clear valuation methods from the outset to avoid disputes when the option is exercised.

Industry trends suggest a recent uptick in investors requesting put options, which reflects growing sophistication in SMB deal structures. However, not all deals include both types of options — the specific combination depends on factors like deal size, operator experience, and investor requirements.

Lastly, enforcement challenges can pose significant hurdles. Even well-structured options may face practical limitations — a company might lack capital for a buyout, or parties might dispute valuation methods. Some jurisdictions place restrictions on share buybacks, particularly for larger ownership stakes. This makes having clear protocols for resolving these issues, including potential mediation or arbitration processes, as important as any part of the deal.

Structuring options effectively 

Two common frameworks exist for structuring call and put options in SMB deals: Time-based and return-based. Time-based structures activate after a set period, typically 5 to 7 years from the initial investment. Return-based structures trigger when specific performance metrics are met, such as achieving a certain multiple on invested capital (MOIC) or internal rate of return (IRR).

Many deals combine these approaches to align incentives. For example, options might become exercisable only after investors receive a 2x return and 5 years have elapsed. This ensures investors participate in the business's growth phase while also giving operators a clear path to full ownership.

The valuation mechanism plays an equally important role. Most structures will start by a negotiation between the company and investors, using an EBITDA multiple or analysis of comparable companies to value the business. If those sides do not reach an agreement, then a certified business appraisal will be commissioned to determine the fair market value. This is quite similar to how negotiations are approached with real estate deals.

Legal considerations play a key role, too. Options need to align with broader corporate governance documents and comply with relevant regulations. This often requires experienced legal counsel to ensure enforceability and to avoid potential conflicts with other shareholder rights. For operators who have used SBA loans to acquire a business, oftentimes an equity call or put may require consent from the SBA lender.

Market size influences option structures significantly. For deals under $5 million, simpler frameworks often suffice. Larger transactions typically require more sophisticated mechanisms, including detailed provisions for partial exercises and staged buyouts. Understanding your deal's place in the market helps determine appropriate complexity levels.

The risk profile of the business can also shape option design. For instance, a software as a service (SaaS) company with recurring revenue might use a straightforward EBITDA multiple, while a construction company with significant equipment assets might require both asset valuation and earnings metrics. In that same vein, companies with high customer concentration or regulatory exposure may need additional provisions to account for these risks — like a medical device manufacturer where a single hospital system accounts for 40 percent of revenue.

Guidance for investors

Before entering an SMB deal with put or call provisions, investors should consider several factors:

• Capital requirements: Assess the company's ability to fund potential buyouts

• Alignment: Ensure option structures match investment goals and timeline

• Documentation: Review all shareholder rights and restrictions

• Market conditions: Consider how industry trends might affect future valuations

Looking ahead with SMB call and put options

The role of call and put options in SMB deals continues to evolve. As the market matures and more investors enter the space, these mechanisms are becoming increasingly sophisticated. Standard practices are emerging around valuation methods, trigger conditions, and documentation requirements.

For entrepreneurs considering an SMB acquisition, understanding these options early in the deal process is essential. They're not just exit mechanisms – they're tools for aligning the long-term interests of operators and investors. When structured properly, call and put options can provide the flexibility both parties need while maintaining focus on building sustainable business value.

Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.