What is an Abandonment Option?

Abandonment options are a common clause found within a number of different types of financial agreements. Essentially, the abandonment option provides for the orderly termination of investments of resources by either party should it be determined that the investment is not turning out to be sufficiently profitable to one or both parties. Here are some examples of how the abandonment option can work within different circumstances.

In the case of an investment of capital into a corporation, both parties into a financial contract with the expectation that the loan will be repaid under specific circumstances, either in the way of regularly scheduled payments or the payment of a specified number of balloon payments. Usually, there is a fixed period of time in which the payments are to be made, along with any interest charges that have been agreed upon in the text of the loan agreement. Should the lender determine that the company is not utilizing the funds in a manner that will allow them to generate revenue to repay the loan, the lender may choose to exercise the right to abandon the project and cease to supply capital to the corporation.

Another example has to do with an agreement among a group of investors that have pooled resources in order to trade stocks and bonds. All parties enter into a binding document to contribute funds to the project. However, should any of the parties experience financial reversals, he or she would be able to exercise an abandonment option, ask to close out investments made, and offer the remaining parties the chance to either purchase his or her shares at fair market value or bring in another partner. Rather than going through simple abandonment of the resources already contributed to the project, the exiting partner would be able to recoup at least part of the investment, while the remaining partners would not be negatively impacted at all.

Financial planners often include abandonment options in their working agreements with clients. The presence of the abandonment option allows the planner to release a client who seems to not be interested in following the structure of the financial plan laid out for the best interests of the client. This frees the planner from spending more time with someone who is not responding to the plan, and redirect time and resources to other clients who are attempting to work toward a more secure financial future.

A properly written abandonment option is not intended to penalize either party for choosing to end the agreement. Instead, the option provides a means of acknowledging that the project or plan is not working as expected, making it possible for both parties to part ways and seek opportunities elsewhere.