What is a cross option agreement and does my business need one?
When business owners enter into a company protection policy such as a shareholder or partnership protection policy, a cross option agreement can come into play. Also known as a double option agreement (or single option agreement in the case of critical illness cover) this type of agreement can help guarantee the transaction between the life insurance payout and the business shares.
What is shareholder protection?
Shareholder or partnership protection is a life insurance policy taken out on one or more shareholders. Typically, with this type of life insurance, the remaining shareholders are chosen as the beneficiaries of the insurance policy. This enables the remaining shareholders to have the funds to purchase the share back from a shareholder in the event of a death.
What happens when a business shareholder passes away?
When a shareholder passes away, their business share falls into their estate. This means it will normally pass to a family member. In some cases, this may be what the shareholder wished, and the family member may wish to become involved in the business. However, more often than not, the family would rather sell the share in order to be able to be supported financially after a loss.
If the remaining shareholders do not have the financial means to purchase back the share, this can cause problems. Either, the family will sell to a major competitor or hostile buyer or they remain in the business without little or no interest in making business decisions.
Shareholder protection policy
A shareholder protection policy can help to protect against a possible unwanted new owner of the share. Instead, this life insurance policy pays money to the shareholders’ themselves. This is to provide the financial means to afford to buy the share from the family.
That’s where a cross option agreement comes into play.
Cross option agreement
A cross option agreement is an agreement entered into by all the shareholder. It is put in place to ensure that the sale of the share goes smoothly. Each shareholder takes out a policy on either themselves, where the money goes to the remaining shareholders or on each other, where the money goes back to themselves.
This agreement is then put in place for shareholders to grant each other put and call options over the shares. Each partner agrees to co-operate fully during a claim. It also gives each shareholder the option to purchase life insurance to protect the business.
Call option agreement
A cross option agreement consists of either a ‘call’ or ‘put’ option that can be executed in the event of the death of a shareholder. The call option states that in the event of the death of a shareholder, the remaining shareholders can ‘call’ the shares. This is usually from the family but can be from any personal representative of the estate. The shareholders request to purchase the shares for the value agreed upon in the policy. The family, in return, sell the shares to the remaining shareholders on the terms agreed.
Put option agreement
A put option agreement is where the shareholder’s family request to sell the shares for the agreed value. In return, the surviving shareholders agree to purchase the shares from them in line with the terms of the policy.
Single option agreement with critical illness
In the event that the shareholder takes out a critical illness policy, the agreement is slightly different. This is what is called a single option agreement. The terms are such that if a shareholder were to fall critically ill and wish to sell their shares, the remaining shareholders agree to purchase it. However, they cannot become entitled to the share without consent from the individual insured. For example, if they wish to buy the share from the critically ill shareholder, he or she does not have to agree to sell.
A cross option agreement helps to facilitate the sale of the share back to the business shareholders. It allows the family to be financially supported, and the business to continue running as normal after a loss. With this agreement in place, it ensures the shareholder protection policy is used in the right way. It can help to ease the process and make for a quick and straightforward transaction.
A cross option agreement is an integral part of a shareholder protection plan. Business shareholders should be aware of what is entailed. Therefore, making sure your life insurance policy is used as intended.