What Is an Exit Option?
An exit option is a clause in a financial agreement that enables one or more parties to terminate the arrangement prior to its planned completion date. Such options are commonly used in the investment arena by creditors, debtors and shareholders. Finance companies and private investors often include at least one exit option in major commercial contracts.
Many debt arrangements include an exit option, which is commonly known as a "call option." Publicly traded companies and government organizations often borrow money from investors by selling bonds which are a type of debt security. Bondholders receive interest payments for the duration of the bond term but if the bond agreement includes a call option then the bond issuer can payoff the debt before the loan agreement's maturity date. In these situations, bond issuers are said to have called in the loan. Entities normally use this exit option if less expensive forms of financing become readily available after the debt agreement comes into effect.
In many instances, bondholders and shareholders also have the ability to terminate an investment arrangement by taking advantage of an exit option known as a put. Normally, the purchase contract includes a clause that enables the shareholder or bondholder to sell the security to the issuer or another party for a pre-determined price at some point in the future. The buyer may or may not decide to use the put option but the other party in the equation has a legal obligation to buy the security if the put option is exercised.
Like investors and securities issuers, banks often include exit options in loan agreements. Many commercial loans are annually renewable; this means that the bank has the option of terminating the agreement if the borrower's financial circumstances have deteriorated by the renewal date. In such circumstances, banks can demand immediate repayment of the entire loan balance. On a collateral secured loan, a bank may have the option of foreclosing and selling the property that secures the loan as part of the exit option. In some countries, borrowers also have exit options on bank loans that enable people to cancel loans within a certain period of time of the loan agreement being signed.
Aside from standard exit options, many investors and business owners create escape clauses that enable them to reduce their ownership stake in a firm or piece of property. A business owner may enter into a binding agreement under which the other shareholders agree to buy out that owner's share of the business if certain events unfold. Business owners also include exit options in construction contracts and purchase agreements that enable either party to nullify the deal if certain circumstances arise.
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