The cross-purchase is one of the two main ways (“stock redemption” the other) a buy-sell agreement can be structured to provide your company with a succession plan.
Under a cross-purchase plan, each company shareholder agrees in advance to buy the shares of the withdrawing shareholder while the withdrawing shareholder agrees to sell his or her shares to the remaining shareholders. The corporation is not involved in the transaction.
Therefore, when shareholders execute a cross-purchase agreement to buy each others’ stock, they must have the personal funds to do so when a shareholder withdraws. For this reason, life insurance is commonly used to provide such funding.
Each shareholder buys a life insurance policy on the life of every other shareholder, pays the premiums out of their own pocket and is the policy’s beneficiary. Since each shareholder could have multiple policies to maintain, cross purchase agreements work best when the number of total shareholders is relatively small. For example, if a company had 7 shareholders, 42 life insurance policies would need to be purchased.
Each company’s situation is going to be unique and there is no one-size-fits-all method in approaching buy-sell agreements. Factors such as the number of shareholders, their relative ages, available personal funds, company valuation, insurability, taxation and the events that mandate shareholder withdrawal must all be considered in crafting your company’s buy-sell agreement.