Cross Option Agreements
If you are a small or medium sized enterprise run by owner-managers, the death of a shareholder can have a major impact on the company. It can cause major disruption, particularly if the shareholder is a key decision maker within the business. Will the deceased shareholder’s shares pass to a family member? What if they are inexperienced or have no interest in the business? What if they do not want the shares? Can the other shareholders purchase the shares of the deceased?
A Cross Option Agreement grants each shareholder an option for their shares in the event of their death to:
- Grant to the surviving shareholder(s) a right to buy the deceased’s shares; and
- Enables the deceased’s family to compel the surviving shareholders to buy the deceased’s shares
The question of whether the surviving shareholders have funds to buy the shares at the time of death may well be an issue. For this reason, the option is usually backed by an appropriate life assurance policy taken out by each shareholder to ensure there are funds available to cover the purchase of shares and avoid cash flow issues.
The valuation at which the shares of a deceased can be purchased must be agreed between the parties and set out in the Cross Option Agreement. This may be the fair market value of the shares at the time of acquisition, or an agreed value fixed in advance, or simply the sum of the life policy in relation to the deceased shareholder’s shares.
- Life Assurance / Key Man Policies
The value of the shares should be regularly assessed and the policies updated regularly, usually every 12 months, or if a significant life event occurs. If the policy is not updated, it may not cover the value of the shares of the deceased shareholder.
When considering a cross option (backed by a life policy) the shareholders need to consider whether the risk of shares falling into unwanted hands (ie. a deceased shareholder’s family members) outweighs the cost of the insurance premium. For some companies, the loss of a key man could have adverse consequences and significantly change the business.
There are tax implications to shares changing hands. By structuring the transfer of shares in this way in the cross option, business property relief may be available and, in valid circumstances, relief from inheritance tax. Please note that tax law can change so you are advised to consult your tax advisor.
Cross Options can also be used in the event of serious/critical illness and bankruptcy situations, but this is outside the scope of this article.
Please also refer to the following related blogs:
Shareholders Agreements and Articles of Association: Does my company need them? shorturl.at/rMNU2
Update: Shareholders’ Agreements – Is your house in order? https://www.mlplaw.co.uk/update/