Cross-Options – what are they?

Barry Riley

Succession planning is something that each business should consider, particularly on the death of one of the owner managers. This is because the deceased’s interest in a business (whether as a partner or as a shareholder of a company) forms part of the deceased’s estate to be distributed to the beneficiaries.

Therefore, the remaining owner managers may find that they are forced to work with someone they do not know or would prefer not to work with. In any event, it would be someone they did not necessarily contemplate working with at the time of starting up the business relationship.

Whenever anyone is entering into a new business venture whether with a friend, a relative or just a business colleague, we would always recommend that an agreement is put in place to regulate how the parties manage the business, make decisions, share the profits and capital, and what happens on the exit of one of the parties. In particular, what happens when a party dies can have a profound effect on whether the business is able to continue afterwards.

Solving the problem

The most widely used and preferable solution to resolve the problem is by all the co-owners entering into a cross-option agreement, the provisions of which are triggered on the death of each co-owner. Normally this would give the surviving co-owners a period of time in which to call for the deceased’s interest in the business to be sold back to them. If within that period the call element of the cross-option is not exercised, the personal representatives of the deceased will then be able to force the surviving co-owners to buy the business interest.

If both the surviving co-owners and the beneficiaries of the deceased’s estate are happy to continue to work together, then there is no obligation to exercise the cross-option. If either party is not happy with the potential of being in a business relationship with the other, then the cross-option provides a get out. The value to be attributed to the interest in the business at the point of exercising the option would be determinable by a calculation, taking into account such circumstances as are set out in the cross option agreement.

How to pay?

Clearly, the surviving co-owners need to make sure that should they be required or wish to buy the deceased’s interest in the business, they are in funds to do so. Neither the business nor the co-owners are likely to want to put aside a cash lump sum equivalent to the value of any one co-owner’s interest in the business, as this money could be put to better use, such as reinvestment into the business. Therefore, the co-owners are unlikely to be in funds to buy out the business interest without some form of financial assistance.

At the same time as entering into the cross-option arrangement, the co-owners should also take out a life assurance policy on every co-owner. The life assurance policy would pay out the sums to the beneficiaries under the trust created by the insurance policy, to be used as payment for the interest in the business.

Raising a question

This does however raise the question of whether, should the cross-option not be exercised, the deceased would have wanted the cash lump sum to go to the co-owners or to the beneficiaries of the deceased’s estate. The standard trust documents provided by insurance companies are not usually flexible enough to deal with such a situation.

At Metcalfes however, we are not only able to prepare the cross-option agreement,but can also create a flexible trust which would allow each of the co-owners to set out in detail how they would like the policy fund to be treated eventually.

Barry Riley
briley@metcalfes.co.uk
DDI – 0117 9453 042

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