If you co-own a business (whether as a company, LLP or partnership) your insurance broker, relationship manager or financial adviser may have talked to you about taking out business protection life policies backed up by cross-options. This article explains the purpose of business protection life policies supported by cross-options and how they work in summary.

Where a shareholder, partner or member (i.e. business owner) dies, life policies supported by cross-options enable the surviving business owners to fund the buyback of the deceased owner’s shares/interest in the business using the proceeds of the life policy (which will ultimately pass to the family of the deceased owner). The death of a co-owner is often unexpected and so the life policies remove the burden on the surviving owners of having to find the finance to purchase the deceased owner’s shares at short notice while also ensuring that the deceased’s estate gets value for their share/interest in the business.

How it all works

Each owner of the business (i.e. shareholder, member or partner) takes out a life policy in favour of the other owners for a specified value. The value of the policies should ideally reflect the value of each owner’s share or interest in the business (which may be reviewed periodically to account for fluctuations in the value of the business). For tax purposes each life policy is usually written into a discretionary trust.

In addition to the life policies, cross-options should be put in place (either in a standalone agreement or in a shareholders agreement). It is the cross-option provisions which provide the mechanism for the purchase of the deceased owner’s shares/interest. The cross-options have to be drafted and structured very carefully so as to minimise the risk of unexpected tax charges arising on the death of an owner.

In summary, the cross-option provisions should operate as follows: –

  • On the death of a business owner, the surviving owners will have the option to require the deceased owner’s personal representatives to sell their shares/interest in the business to the surviving owners.
  • Conversely, the personal representatives of the deceased owner will have the option to force the surviving owners to purchase the deceased owner’s shares/interest.
  • Once an option has been exercised completion of the sale and purchase of the deceased owner’s shares/interest in the business should occur within a set period and be subject to certain conditions (for example, receipt of the grant of probate and life policy proceeds).

In terms of setting the price for a deceased owner’s shares/interest this can be either a fixed amount or linked to the proceeds of the relevant life policy.

When implementing cross-options to support life policies, there are a number of important considerations which will depend on the circumstances and the business owners’ objections and wishes. As mentioned above, thought should be given to revaluation of the business and policy amounts (for instance, a periodic business valuation with an obligation to amend the life policies in line with any change in valuation accordingly).

As term life policies are often taken out for the purpose of business protection, thought should be given as to what happens if an owner become uninsurable at the expiry of the term or if the premiums become commercially unjustifiable. Consideration should also be given to what happens if a co-owner does something to invalidate their insurance, leaving a shortfall when it comes to the policy pay out.

Most insurance companies often have their own standard cross-option agreements but the “one-size fits all” approach often doesn’t meet everyone’s objectives and wishes. If you are considering taking out business protection life policies then you should seek legal advice as to the terms and operation of the cross-options.

If you would like to discuss any aspect of life policies and cross-options, then please give Alex Clifton a call on 0116 289 7000.

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