Key Takeaways

  • A cross purchase plan is a type of buy-sell agreement where individual business owners agree to purchase the ownership interest of a departing owner, ensuring business continuity.
  • These agreements are typically triggered by events such as death, retirement, disability, divorce, or bankruptcy of a partner.
  • A cross purchase plan can be funded through life insurance policies, sinking funds, loans, or installment payments, providing financial security for ownership transitions.
  • This structure offers significant tax advantages, including a stepped-up basis for purchasing partners, potentially reducing future capital gains.
  • While ideal for smaller companies with few owners, cross purchase plans become more complex and costly as the number of owners increases.
  • The agreement should include clear terms on valuation, funding mechanisms, buyout triggers, and ownership distribution to minimize disputes.

A cross purchase buy sell agreement facilitates the transfer of ownership interests of a company. When an owner of a business decides to retire, dies, or is otherwise incapacitated, this agreement will allow the remaining shareholders to purchase the owner's shares.

What is a Cross Purchase Buy Sell Agreement?

Cross purchase buy sell agreements have a variety of purposes. One of the main benefits of this document is that it allows the remaining partners in a business to purchase the shares of a partner who is leaving the company. In addition, this document will decide how these shares can be purchased or distributed. For instance, many cross purchase buy sell agreements require proportional distribution.

In essence, a cross purchase buy sell agreement is a contingency plan for when a partner leaves a business and their shares become available. The death of a partner is one of the primary triggers of a cross purchase buy sell agreement. These agreements can include a variety of protections. For example, one partner may buy life insurance policies for the others, and when a partner dies, the payout from the policy can be used to purchase their shares.

When a partner retires, this event can also trigger a cross purchase buy sell agreement. It's possible for these agreements to include a set price for buying out a retiring partner. This amount will need to be regularly updated. In other circumstances, the amount of the buyout can be calculated by an independent appraiser or by using a valuation formula.

In a business where the partners are around the same age, a cross purchase agreement can be very beneficial. However, in larger businesses with multiple partners, the need to purchase life insurance policies for each partner can result in problems.

For example, if there is a large age gap between partners, the younger partners will be required to pay more expensive life insurance premiums. In businesses with a large number of partners, it's possible to consolidate a cross purchase buy sell agreement with an individual trustee. This trustee would have several duties:

  • Owning the partner's life insurance policies.
  • Collecting the payout when a partner dies.
  • Purchasing and distributing the deceased partner's shares.

Benefits and Drawbacks of a Cross Purchase Plan

A cross purchase plan offers a straightforward and flexible way for co-owners to manage ownership transitions, but it also comes with certain challenges. Understanding both sides helps business partners decide whether this structure is right for them.

Key Benefits:

  • Stepped-Up Basis Advantage: When owners purchase shares directly from a departing partner, they receive a stepped-up cost basis. This means if they later sell their shares, they may owe less in capital gains tax.
  • Control and Continuity: Remaining owners maintain direct control of the company without involving the business entity itself in the transaction.
  • Customizable Terms: Cross purchase plans can be tailored to specific business needs, including predetermined buyout triggers, valuation formulas, and funding strategies.
  • Financial Predictability: Life insurance policies are often used to fund the purchase, providing immediate liquidity upon an owner’s death and ensuring that ownership transfers without financial strain.

Potential Drawbacks:

  • Complexity with Multiple Owners: As the number of owners increases, the plan becomes more difficult to manage. Each owner may need to purchase multiple life insurance policies — one for each co-owner.
  • Funding Challenges: Younger owners may face higher premiums when purchasing life insurance on older partners.
  • Coordination Issues: Without proper legal and financial planning, disagreements can arise over valuation methods or buyout terms.

How to Write a Cross Purchase Buy Sell Agreement

The best way for business partners to develop a cross purchase buy sell agreement is to hire a knowledgeable attorney. An attorney can help partners decide how the agreement can be formatted and can then write the agreement. While the agreement is being written, several possible events must be considered:

  • Buyout events
  • Valuation and funding
  • Buy-sell variations

Virtually every cross purchase buy sell agreement will include a buyout provision that will be triggered upon the death of a business partner. However, several other possible buyout events must be kept in mind by partners. For example, if a partner gets divorced, it's possible that their shares will be given to their former spouse in the divorce settlement, which is a situation the other partners may wish to avoid.

Other buyout events that should be considered when writing a cross purchase buy sell agreement include a partner becoming disabled, a partner declaring bankruptcy, or the decision to fire a minority partner.

Valuation is another issue that can influence how a cross purchase buy sell agreement will be written. When writing the agreement, the partners will need to agree on their business's value. By agreeing upon a specific amount, partners will be able to prevent a future dispute when one partner decides to leave the business or a partner dies. Calculating an accurate value for the business can also make it easier to fund a buyout.

In a cross purchase buy sell agreement, valuation can be addressed multiple ways:

  • Calculate the value based on a formula that will be added to the agreement.
  • Require that partners valuate the business every year. If they don't complete this task, a formula in the agreement can be used.
  • Choose a professional appraiser to calculate a business value.

Partners also have several options for funding a buyout:

  • Use a conservative investment or a savings account to institute a sinking fund.
  • The business can get a bank loan.
  • If it is allowed in the cross purchase buy sell agreement, the buyout can be paid in installments.
  • Disability and life insurance policies can be purchased for each owner.

Tax Considerations and Legal Implications

Tax treatment is a crucial factor in designing an effective cross purchase plan. Unlike entity-purchase agreements — where the company buys back the shares — a cross purchase plan allows individual owners to personally acquire the interest. This approach provides significant tax advantages:

  • Basis Adjustment: The purchasing owners receive a higher tax basis in their acquired shares, potentially reducing their capital gains taxes when they sell their interests.
  • No Corporate Tax Consequences: Because the company itself is not involved in the transaction, there’s no impact on the corporation’s tax status or retained earnings.
  • Estate Planning Benefits: These agreements can also serve as valuable estate planning tools, helping ensure that ownership transitions smoothly to remaining partners or heirs without triggering probate disputes.

It’s critical to consult legal and tax professionals when drafting these agreements to ensure compliance with federal and state laws, properly structure funding methods, and align the agreement with broader estate and succession planning goals.

Best Practices for Implementing a Cross Purchase Plan

Implementing a successful cross purchase plan requires more than just drafting an agreement — it involves careful planning, regular updates, and strategic funding. Here are some best practices:

  1. Review and Update Regularly: Valuations, ownership percentages, and funding arrangements should be revisited annually to reflect changes in the company’s financial position and ownership structure.
  2. Coordinate with Estate Plans: Align the buy-sell agreement with each owner’s estate planning documents to avoid conflicts in asset distribution.
  3. Use Life Insurance Strategically: Where possible, use life insurance to fund the agreement — especially for death-triggered buyouts — to ensure liquidity and ease of execution.
  4. Clearly Define Buyout Triggers: In addition to death and retirement, consider including events such as disability, divorce, bankruptcy, or breach of fiduciary duty.
  5. Involve Legal and Financial Advisors: A well-structured agreement should involve professionals who can anticipate legal issues, tax implications, and valuation challenges.

Frequently Asked Questions

  1. What is the main purpose of a cross purchase plan?
    It ensures business continuity by allowing remaining owners to purchase a departing owner’s shares when they retire, die, or leave the company.
  2. How is a cross purchase plan funded?
    Funding can come from life insurance policies, company profits, sinking funds, bank loans, or installment payments, depending on the agreement terms.
  3. What are the tax benefits of a cross purchase plan?
    Purchasing owners receive a stepped-up cost basis on acquired shares, which can reduce capital gains taxes in the future.
  4. When should a cross purchase agreement be updated?
    It’s best to review the agreement annually or whenever there’s a significant change in the business value, ownership structure, or tax law.
  5. Is a cross purchase plan suitable for all businesses?
    It’s most effective for businesses with a small number of owners. In larger companies, the complexity of multiple insurance policies can make entity-purchase agreements more practical.

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