Death is never a nice thing to think about. It’s why according to YouGov over 61% of adults in Britain still don’t have a will, despite knowing their importance. But if you run a business, then part of your risk planning and management has to include the death of one or more owners as a possibility. And just like any other risk in your business, you need to understand what that means, what the consequences could be, and how you can best handle the situation if it did happen. In this case, the solution is a little document called a cross-option agreement. This blog focusses on owners of limited companies but they can apply equally to partnerships.
What are Cross-Option Agreements?
Ask yourself this. When a shareholder in your business dies, what happens? Who benefits from their estate? And will that person want to take an active role in the business? Would they want to sell those shares back to the company? And is there cash available to pay for them? Or might they be tempted to sell those inherited shares to a rival instead?
All of those things can and have happened to businesses who have suffered the death of a shareholder without a cross-option agreement in place. To put it simply, a cross-option agreement is a legal document that prevents disruption to the business if a shareholder dies, by giving ‘options’ over their shares in the event of their death. Essentially, it states that, in the event of a shareholder’s death:
- The surviving owners will have the option to require the deceased’s representatives to sell the deceased’s shares in the business to the surviving owners.
- The representatives of the deceased shareholder will have the option to force the surviving owners to purchase the deceased’s shares in the business.
This keeps the business operations running smoothly, and it gives peace of mind for shareholders’ families, knowing that they will always have a cash buyer for shares if the worst should happen.
Are They Really Necessary?
If you have multiple shareholders, then absolutely. It’s essentially an extension of estate planning, and a way to make sure that if you do die, your shares are dealt with in the way you wish, and in a way that won’t cause stress or disruption to your loved ones, or your business. It also protects the business from a lot of different things, including someone who inherited shares in your business trying to exert control using those shares, or selling them to the highest bidder (or a competitor). A cross-option agreement legally details the process for share transfer in the event of death, and when worded correctly can also prevent other legal issues from being triggered.
Why the Fine Print Really, Really Matters
Now, we usually recommend that businesses get all of their legal documents at least looked at by a legal professional, if not written wholly by them. However, there are actually very few documents that HAVE to be written by a lawyer, and this isn’t one of them. But it’s one of the ones we strongly urge you to seek professional help on, because if you get the wording slightly wrong, you could end up losing some tax reliefs you probably want to keep.
For cross-option agreements, it’s essential that the person writing it understand the legal terminology, so that they don’t fall foul of certain inheritance tax provisions, which could render the transfer of shares ineligible for business property relief, and lead to a bill for the deceased’s estate. The key element to focus on is making sure that the ability for shareholders to buy the deceased’s shares (and the deceased’s representatives to sell them) is drafted as a right, and not an obligation. This might seem like a small thing, but if either party is under a legal obligation to buy or sell those shares, then the transfer is then subject to a binding contract for sale. This means that for inheritance tax purposes, it will be treated as a transfer of cash, and business property relief would be lost.
Funding the purchase
Shareholder Protection (limited companies) and Partnership Protection (partnerships and limited liability partnerships) is a business insurance that pays out a lump sum to the business, providing the financial means to purchase the shares under a cross-option agreement. You can also include critical illness cover that will pay out in the event of the shareholder falling ill. It’s always best to seek professional advice when it comes to business insurance and the team at Covertree Financial Services can help you arrange your shareholder protection policy to support the cross option agreement.
Drafted properly, a cross-option agreement ensures that the deceased’s beneficiaries can extract value from the company their loved one worked for in a tax-efficient way, and in a way that causes minimal disruption to the remaining shareholders. In other words, it keeps everyone happy and makes an otherwise complicated time much simpler for all.