Purpose of the Cross-Purchase Buy-Sell Agreement
Two concepts stand at the root of all cross-purchase buy-sell agreements: protection and fairness. A surviving business owner wants to be protected from interference by outsiders when a co-owner dies. Concurrently, a business owner wants to assure fair treatment of his or her heirs in the event of death.
Shareholders and partners use cross-purchase agreements in the same way corporations and partnerships use entity or stock redemption agreements. The distinguishing factor is that, with a cross-purchase agreement, each owner buys a policy on the life of every other owner. Under an entity or stock redemption agreement, the business itself owns a policy on each owner. Regardless of whether the buyout is cross-purchase, entity, or stock redemption, a properly drafted buy-sell agreement:
- minimizes the possibility that the business might fall into the hands of outsiders
- minimizes the possibility that the parties involved will not be able to agree on a value for the business at the death of an owner
- provides the deceased owner's estate with a ready purchaser for the business interest.
A cross-purchase agreement helps to protect everyone's financial interests, business owners and heirs alike. And funding the agreement with life insurance helps to provide a secure foundation for the agreement.
How the Cross-Purchase Agreement Works
Assume Grant, Lee and Jackson are equal partners in a business with a total value of $450,000, which means each has an interest of $150,000. Under a cross-purchase agreement, agreements are made that at the death of any partner, the other two will purchase his or her interest from the estate.
In our example, Grant and Lee would each purchase a $75,000 face amount policy on the life of Jackson. The total insurance in force on Jackson's life, then, is $150,000—enough to purchase his or her business interest. Similar arrangements are made for each partner.
With a cross-purchase agreement, the individual owners own the policies, pay the premiums, and are named beneficiaries, e.g., Jackson is the insured and Grant is the owner and beneficiary. At the death of one owner, the surviving owners receive the insurance proceeds and use them to purchase the deceased owner's interest from his or her estate.