Have you thought about what might happen to your company if one of your shareholders dies?

It is not something that most people want to think about when embarking on a new business venture together, but what happens if one of you dies?

Of course, we all hope that this is not going to happen, but the sad reality of life is that occasionally, it happens.

The shares will then fall into the deceased shareholder’s estate which gives rise to two alternative situations:

1. The remaining shareholder(s) now find themselves with a new business partner who perhaps knows nothing about the business and has no interest in running it, but who could still have significant influence over the future of the company; and/or
2. The beneficiary of the estate could now find themselves with some shares that have some significant value, but unless the other shareholders can afford to buy them, or the company can afford to carry out a share buyback, the beneficiary of the estate is unable to realise the value of the shares and we are back to the scenario of all parties now being trapped in a relationship that they never envisaged and do not want.

There is, however, a solution: a Cross Option Agreement.  This is an agreement entered into between the shareholders of a private limited company under which each shareholder grants the other shareholders ‘put’ and ‘call’ options over their shares which are exercisable on the death of one of their number.  In addition to entering into the Cross Option Agreement itself, at the same time, the shareholders take out life insurance policies, which are written in trust for the other shareholders in the event of their death.

A ‘call option’ enables the holder of the option to call on a third party (in this case the beneficiary of the estate who now holds the shares) to sell the shares now held by them to the other shareholder(s).  In the event that none of the surviving shareholders choose to exercise their right under the Cross Option Agreement to call for the shares, the beneficiary can exercise their right to the ‘put option’ to force the remaining shareholder(s) to purchase the shares from them.  This is where the life insurance pay out comes in as this enables the purchasing shareholders to pay the true market value for the shares that are going to be purchased under the Cross Option Agreement.

The obligations under the Cross Option Agreement are legally binding so all parties are bound by its terms and there is no opportunity for anyone to ‘dig in’ and refuse to either buy or sell.

There are two important points to consider however:

1. To review the level of cover under the life insurance policy at regular intervals to ensure that the insurance payout keeps up with the increase in value of the company’s shares; and
2. To enter into this type of arrangement as early on as possible in the company’s lifecycle as insurance premiums for this type of policy are likely to increase with age and could become prohibitively expensive to make the scheme viable.

If you are interested in planning for the future of your company and your family and want to know more about Cross Option Agreements, please get in touch.