Cross Option Agreements – What & Why
Let’s get straight to the point. When a shareholder or partner in a business dies, their share of the business forms part of their estate and ultimately passes to their beneficiaries. The shares of the business are simply another personal asset.
In the case of a controlling partner or shareholder, this could mean the direction and running of the
business is dictated by people not associated with it. Suddenly your trusted business partner or fellow director has gone and their vote belongs to their beneficiaries.
The first question here is; ‘Who will this person be?’ The follow up question is; ‘Can I work with them?’ or ‘do I want to work with them?’
For many SMEs the beneficiary will be the partner or director’s spouse.
The Legal Agreement (Cross Option)
There should normally be a legal agreement in place giving the remaining partners or shareholders the right to purchase the shares. This means that the beneficiary is legally obliged to sell the shares, meaning that the remaining partners/directors take over that shareholding and the business continues.
This agreement to purchase and sell is called a ‘Cross Option Agreement’.
For any business where there are multiple shareholders or partners then a Cross Option Agreement should be a mandatory requirement.
The big wonder is why more companies don’t get these agreements in place, there are loads of templates to use (two are attached below) and the cost of putting it in place is negligible at most.
The Financial Problem
The big problem with a Cross Option Agreement is how to make the purchase of shares. The beneficiary will have a shareholding which you are obliged to purchase within a period of time, so how do you make the purchase?
Even for small SMEs the cost of buying back half your company can be significant. It is also common for lenders to be cautious about borrowing for this purpose, in a lender’s mind the company is taking on more debt for no change in growth at a time of upheaval.
The solution is generally to put a Cross Option Agreement in place then support it with life or critical illness insurance which will pay out for the purpose of making the share purchase. In this way the remaining partners/ directors have the option to purchase the shares back and they have the cash to make the purchase.
If you have read this far and realised your business does not have a Cross Option Agreement then contact your commercial financial advisor or give me a bell and I will put you in touch with someone good.
Cross Option Templates
There are loads of templates out there for businesses to use. Typically an IFA will have their own version, however if you want to see how it is worded then try one of the Cross Option templates below. These are all third party documents so treat them accordingly.
For any questions about this post then please add them above or contact me via the website and we can go from there.
By Dave Farmer
Both the templates above are 3rd party documents, always check with your IFA or legal advisor before signing. The templates are provided as a tool to use and a guide as to what you need to do, please use them as such.