Cross Option Agreement

Many small businesses are set up and run through the medium of a limited company and this is owned by just its two founders.

There is nothing wrong with this arrangement but consider what happens on the death of one of parties. There are some undesirable outcomes:

  • The survivor may wish to purchase the shares of the deceased shareholder but the executors of that person may not wish to sell them.
  • The widow(er) of the deceased shareholder may wish to have involvement in the running of the business which the survivor may not appreciate.
  • The executors of the deceased shareholder may wish to sell the shares of the deceased but the survivor either may not wish to buy them or may not have the funds to buy them. If the survivor cannot raise the money they may be sold elsewhere.
  • A binding agreement between the parties entered into before death can result in the loss of Business Relief for Inheritance Tax purposes (Business Relief is an exemption taking that asset out of the chargeable estate when calculating inheritance tax and is generally available on the transfer of shares in a private limited company).

So what is the solution?
The answer is to enter in to an agreement that does not create a legally binding obligation on either party to buy or sell the shares but rather gives both parties an option to buy or sell i.e. the survivor has the option to buy the shares of the deceased shareholder and the executors of the deceased shareholder have the option to sell those shares. In either case it is the exercise of the option that creates a binding contract – there is no binding contract beforehand. The secondary problem is to ensure that there are sufficient funds for the survivor to purchase the shares. This is best achieved by both parties taking out life insurance on the life of the other. This will ensure that there is always a fund of money available on the death of one of the shareholders. The shareholders would need to make a reasonable estimate of what the shares would be worth – and of course keep this under review as time goes by.

This type of agreement is generally called a cross-option agreement or a double option agreement.

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