What is a Cross Option Agreement and how can it protect me?

A cross option agreement is an agreement entered into by all of the Shareholders of a company.

The purpose of a cross option agreement is to grant the surviving shareholders an option to purchase the deceased shareholder’s shares at an agreed value. This is known as a ‘call’ option. The agreement would also grant the deceased shareholders personal representatives an option to sell the shares to the surviving shareholders. This is known as a ‘put’ option.

A cross option agreement will set out the price for the shares or a mechanism for calculating the price for the shares. Shareholders will usually take out life insurance policies to pay for the shares in the event one of them dies, given the typical price for such shares and how unlikely it is that the company would have cash so easily available. The life insurance policy can be written in to trust for the benefit of the other shareholders, to ensure there is no inheritance tax on the money. A life insurance policy will ensure funds are available to purchase the shares for the agreed price.

The price of the shares must be fair and can be calculated in several ways including:

• By an accountant;
• By measuring the price to earnings ratio and earnings per share;
• By paying market value for the shares, to be assessed on death

If the deceased shareholder was married and their spouse held shares in the company then the spouses shares are often also required to be bought and sold (this is known as ‘drag and tag’). This, however, will purely depend on the wishes of the parties and the terms of the cross option agreement. In many cases a spouse will not want to run the business and a cross option agreement will ensure the business will continue to trade and the shareholders will have the monies to purchase the shares.

A cross option agreement is designed to give the shareholders a cost- effective way of ensuring both the shareholders and their families get their fair value (one family will receive the shares and the other will receive payment for the sale of the shares).

Cross option agreement v shareholder agreement

Both a cross option agreement and a shareholder agreement are just as important as each other. A cross option agreement is useful when a shareholder passes away whereas a shareholder agreement addresses other matters the shareholders want to deal with, such as how the business will be funded, or the transfer of shares.

• By Nafissa Yousaf, Trainee Solicitor