24 February 2017 by

Do you want a family member running your business after you die?

Cross-option agreements can provide a solution

The death or serious illness of a business owner who is also a manager can sometimes have serious implications for the business unless measures are put in place in advance.

Usually on death a deceased shareholders’ family/beneficiaries will inherit his or her shares under their will, however this could create problems for the business particularly if the beneficiaries have no business knowledge or skills.

A smart way of dealing with this problem is for the shareholders of a company to enter into what is called a “cross-option agreement”. This is an agreement which gives surviving shareholders the option to buy the deceased’s shares, and can provide certainty and peace of mind for the shareholders. The commercial intention of a cross-option agreement is to allow the owner-managers to retain control of the company’s shares, thereby allowing continuity of ownership as opposed to third parties acquiring equity in the company. A cross-option agreement is like a “business will”, which is only triggered on the death of a shareholder. The agreement will set out the basis for the share purchase and the mechanics for how this will work.

Essentially, the way the agreement works is as follows:

  • On death (or when diagnosed with critical illness), the surviving shareholders have the option to buy the shares of the deceased and the deceased shareholder’s personal representatives have the option to sell their shares to the surviving shareholders. It is important that these are drafted only as ‘options’ otherwise stamp duty could be payable. When an option is exercised by either party, the other party is then bound to buy or sell the shares.
  • Each shareholder takes out a life/life and critical illness policy under which any amount payable will be held on trust for the remaining shareholders to pay for the shares. This way, the deceased’s family/beneficiaries will have a willing buyer for the shares and the surviving owner managers will have the funds to purchase the shares.
  • Upon death, the proceeds of the insurance policy can be used by the remaining shareholders to purchase the shares.
  • The agreement will set out the price to be paid for the shares and a method for how the shares will be valued.

We advise clients that the cross-option agreement should include an insurance review policy mechanism to make sure that the cover taken out reflects the share valuation of the company. We often see businesses revalue their shares each year so that the insurance policy proceeds are always in line with the fluctuating value of the shares.

A cross-option agreement must be drafted with careful consideration to the company’s articles of association and any other arrangements and in the context of any transfer provisions and pre-emption rights on death which may conflict with it. It is also necessary to take advice on the tax implications of the arrangement.

If you require further advice on this matter or business succession planning issues contact Sej Lamba on 020 7288 5756 or by email at SehajLamba@boltburdon.co.uk.

You can also contact one of our other solicitors in the Corporate and Commercial team here.

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