As a business owner it is important to constantly consider the lifecycle of your business, past, present and future. Cross-option agreements give you and your business the opportunity to consider the future with certainty.
When a shareholder in a business passes away it has a huge impact on a business. When that same shareholder has a controlling share, or is a director, it has an even bigger impact. That impact is stronger still where that business has not made plans for such an event.
For owner managed small to medium sized private companies a shareholder’s death can give rise to a plethora of problems and adverse consequences for businesses. For example, a beneficiaries’ priorities may not align with those of an existing shareholder. It is possible that there may also be multiple beneficiaries splitting the shares between a group of people, causing practical difficulties.
A cross option agreement can help you plan for this. The basics of a cross option agreement are relatively straightforward: -
- Each shareholder agrees that upon his or her passing his co-shareholders have the option to buy his or her shares, usually at market value (a so-called ‘call option’).
- In addition to this, his or her personal representatives (on his or her passing) have the option to sell his or her shares to the remaining shareholders (a ‘put option’).
The question now is, ‘how will the remaining shareholder will afford to purchase those shares?’ The answer is putting in place an assurance policy for each shareholder. An amount becomes payable under the assurance policy on a shareholder’s passing and is held in trust by the continuing shareholders to pay for the deceased’s shares.
In arranging the share transfer this way, it is possible for a business owner to enable that the deceased’s shares qualify for business property relief. Which, in relevant cases, can provide 100% relief from inheritance tax (as the proceeds of the assurance policy fall outside of the deceased’s estate and are therefore not subject to inheritance tax).
It is important to appreciate that there are intricacies to be considered when drafting a cross-option agreement with a suitable assurance policy. If the cross-option agreement is not drafted correctly it is possible that it will fall foul of inheritance tax provisions. There must be an option, and not an obligation on the party selling the shares and the party buying the shares. If there is deemed to be an obligation upon death, there may be binding contract for the sale of shares. Consequently, for inheritance tax purposes the transfer would be treated as a transfer of cash. The result being business property relief would be lost.
The key benefits of a cross option agreement, an assurance policy, and business property relief are:
- To minimize disruption for a business;
- 2. To allow deceased shareholder’s beneficiaries to extract value from the business; and
- To be tax efficient
This article is for general information only and does not constitute legal or professional advice.
Please contact a member of the ‘Commercial and Corporate Team’ for more information on our advice helpline
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