Does my business need a Cross Option agreement?

As commercial solicitors we often need to speculate on risks and put in place arrangements to mitigate them. Effective risk management, both legally and financially, can release business owners to focus on growth and progress.

Famously, there are only two certainties in life: death and taxes. I am afraid the tax question lies outside the scope of this article but hopefully I can address one particular strategy to manage risk on death – the Cross Option agreement.

For business owners (and specifically here those who trade via a limited company), a will alone may not provide the necessary comfort their affairs will be left in good order. In fact, a will alone can cause difficulty without any further thought.

The problem

Take for example a joint business owner who passes away and his or her estate is left to a spouse. The surviving spouse will inherit shares in a company that they may have no interest or expertise in, and it can leave surviving shareholders with a new business “partner” who wants no involvement.

Notwithstanding the traumatic events that lead to this point, it is not uncommon for disputes to arise and for litigation to follow.

The solution

In short, a Cross Option Agreement is an agreement between the shareholders of a company which is backed by critical illness and life insurance policies taken out against each shareholder’s life.

In essence, each shareholder is granted an option (“call option”) over the other shareholders’ shares, exercisable on death or incapacity.

In that event, the insurance policy provides cash to the remaining shareholder(s) and by the option available to the surviving shareholders in the Cross Option Agreement, the deceased shareholder’s shares can be acquired using an agreed valuation mechanism.

Alternatively, the deceased’s personal representatives can exercise the “put option” which requires the purchase of the shares by the surviving shareholders, utilising the funds from the life insurance policy.

The result is:

1. Surviving shareholder(s) who control the company and who have not had to finance the purchase out of their own pocket; and
2. A spouse or beneficiary receiving a cash payment for the shares. For both parties, this is often a much better outcome.

If you already own a business or thinking about buying a business together with a business partner, a Cross Option Agreement is something to consider. Putting in place a Cross Option Agreement requires careful consideration with your legal and financial advisors, so take advice at the earliest opportunity.

It tends to be beneficial to put these arrangements in place early when you are young and in relatively good health, so that your life insurance premiums are as low as possible.