Cross-Purchase Agreements

A good "cross-purchase agreement" should rest on an expert appraisal. Here's why:

A cross-purchase agreement details how ownership in a business transfers if the owner dies, retires or becomes disabled. A cross-purchase agreement always involves a seller and a buyer. Ideally cross-purchase agreements ensure that sellers (or their beneficiaries) get a fair price for their interests, and equally important, that buyers pay a fair price for those interests.

Unfortunately most cross-purchase agreements are rarely updated. That can be a recipe for disaster. Consider the following scenario that is based on dozens of real-life cases with which SPARDATA is personally familiar.

Years ago two friends started a construction company. At their lawyer's suggestion they signed a cross-purchase agreement; the buy-out price was set relatively arbitrarily at $50,000. (Some cross-purchase agreements use a dollar amount; others use a formula. Any cross-purchase that does not require periodic valuation by a competent appraiser is asking for trouble, as will be obvious in a minute.)

Over the years the business grew and prospered, and before long each owner's annual salary was $300,000. Even though the value of the business was rising, the cross-purchase agreement's exercise price was never updated. In fact the owners didn't really think much about the cross-purchase agreement at all - until the day when one of the owners suddenly and unexpectedly had a massive heart attack and died at his desk.

To make a long story short, the remaining owner cut a $50,000 check to the deceased owner's spouse. She was incredulous. "Is that IT? This is all I get for 50% of this business? I'm calling my lawyer!" For the next two years, when the surviving owner should have been focused 100% on preserving and growing the business, instead he spent most of his time in court.

It is easy to avoid these and other equally ugly scenarios. Make sure that the cross-purchase agreement specifies an actual purchase price, determined by an objective business appraisal; and that the purchase price is updated every three years (or even more frequently if the business' results warrant). Make sure the agreement is funded so that money will be available to carry out the terms of the agreement and the purchase. While there are several funding options -- sinking funds, loans, installments--insurance on the owner's life is one of the most popular options, since it helps ensure that beneficiaries will receive the agreed upon price for the business.