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Business Protection - Cross-Option Agreements

Business Protection - Cross-Option Agreements

Business Protection - Cross-Option Agreements

Date: November 08, 2018

If you are an owner/manager shareholder in a business the death of a fellow business owner can cause significant consequences for both the business and the beneficiaries of the deceased’s estate. It is important that you consider what happens to the business if you or a co-business owner dies as an integral part of your business continuity and risk planning.

Who benefits from the deceased estate and will they want to take an active role in the business or sell out to a rival? Can the remaining owner-managers agree to buy their colleague’s shares in the company? Will the beneficiaries get a fair price and is there cash to pay it?

Cross-Option Agreements are used to cover such situations. They will prevent disruption to the business of the company in the event of a death. A Cross-Option also provides peace of mind by ensuring that the family of a deceased owner-manager will have a willing cash buyer in the event of their death, rather than a share in a business which they may neither need nor want.

A Cross-Option Agreement grants each shareholder an ‘option’ for their shares in the event of their death. This does two things:

 

  1. On the death of a business owner, the surviving owners will have the option to require the deceased owner’s personal representatives to sell their shares in the business to the surviving owners.

 

  1. Alternatively, the personal representatives of the deceased owner will have the option to force the surviving owners to purchase the deceased owner’s shares/interest.

 

In other words, the surviving business owners can keep the shares and the beneficiaries can get the cash value of the shareholding without any active role in the business or protracted negotiations over values and payment mechanisms.

The Option is covered by life insurance policies taken out by each business owner to ensure that there is sufficient cash available in the circumstances to pay for the shareholding. This policy would be taken out at the outset of establishing a Cross-Option Agreement and then reviewed at regular intervals to ensure that there are adjustments to the level of cover if necessary as the fortunes of the business fluctuate. For tax purposes each life policy is usually written into a discretionary trust.

Due to the nature of a Cross-Option Agreement and how they are structured, Business Property Relief for IHT is normally retained over the value of the shareholding unlike other agreements that can cause this important relief to be lost. HMRC will only accept that, where partners or shareholders grant options to buy out each others' interest in the business in the event of death or retirement, this will not constitute a binding contract for sale causing BPR to be lost as long as the PRs of the deceased partner or shareholder are not obliged to sell to the surviving owners of the business and those owners are not obliged to buy. Therefore, a cross-option agreement will not generally lead to the loss of BPR where drafted correctly.

Where 2 or more owner/managers are involved in a business together it is essential to consider arrangements if the worst happened to ensure the surviving owners, the business operation and the deceased persons beneficiaries are all protected.

To start taking the right steps to protect your business and your family contact our trusted Private Client solicitors, accessible across our network of offices including Northallerton, Stockton, Harrogate & York.