Cross Option Agreements – Questions

Cross Option Agreements

Cross Option Agreements – FAQs

Following on from the post about Cross Option Agreements, here are some of the most commonly asked questions about them. This post should cover the majority of common questions, and if you haven’t got a Cross Option agreement in place then hopefully it will encourage you to do so.

Any other questions then please get in touch.

What Is A Cross Option?

An agreement between the shareholders of a limited company (or partners of a partnership) which provides that if a shareholder or partner were to die (or become incapacitated), then the remaining parties would have the option to buy the deceased’s shares in the company from the estate at a pre-agreed value. A Cross Option commits both parties to the transaction and protects the remaining parties control of the company.

What happens if a new shareholder or partner joins the business?

The existing agreement is amended to include the new person. Any agreement already in place between the current shareholders or partners need not be affected.

What happens if the beneficiaries of the estate want to keep the shares and not sell?

The Cross Option agreement is binding between both parties. The remaining shareholders are obliged to make the purchase from the estate, the estate are obliged to sell at the pre-agreed price. The Cross Option removes the ambiguity. Bear in mind that the remaining shareholders will need to pay for purchasing the shares, how this is done is important to plan for.

Do the business owners need a will for a Cross Option to happen?

A will is always highly recommended as it adds further clarity to your wishes. Remember that a business and the shares owned within it are an asset and your will should reflect your wishes. Often a valid will means that the transaction to purchase the shares can happen more quickly.

How is the price that should be paid for the shares decided?

This is the $64k question. The price will be stipulated within the Cross Option agreement. In essence there are a few ways to go about this;

  1. The price quoted in the Cross Option is applicable and the latest price quoted should be used
  2. It is worth reviewing the values every 2/3 years and updating the agreement accordingly
  3. The price should be a fair market value which was established by a professional third party. It is well worth talking to your advisers at this stage as it can impact on taxation as well as ego. There are many ways to value a business, often talking with a business transfer agent can give you the ballpark figures you need

What if the remaining shareholders cannot afford to make the purchase?

The best advice can be to run a life or critical illness policy alongside the Cross Option. This policy can be structured to allow the proceeds to pay out for the purposes of buying the shares back only. Many good commercial IFAs will arrange this for you.

Where there is no such policy in place then either the remaining shareholders inject more cash to make the purchase or the company will need to borrow to complete the transaction. Borrowing for this purpose is not always straightforward.

What are the differences between a Double Option agreement and a Single Option agreement?

A Double Option is often referred to as a Cross Option. It is called ‘Double’ as it requires two things, that the beneficiaries of the deceased sell and that the remaining shareholders or company buy. There is an agreement to both sell and buy.

A Single Option is often used when dealing with critical illness. In this regard the ill director has the option to request that their shares are purchased but is not obliged to sell. The agreement is one way, hence being referred to as a ‘single’ option.

The differences between a Double Option and Single Option make common sense. It protects the ill director from being removed from the business but provides the option for this to happen if need be. If the shareholder dies then there is a mandatory requirement to buy and sell.

How do Cross Options and Insurance affect by tax position?

Ask an expert! The tax position is always subject to change so I would not want to comment. Providing the Cross Option and any linked insurance is correctly worded then HMRC should not have an objection. It is important that your IFA dealing sets things up correctly as it will impact on the inheritance tax payable by the beneficiary’s estate.

 

If you have any other questions then please add your comments above or get in touch.

By Dave Farmer

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