Week 3: Cross-Purchase vs. Entity Purchase Agreements
Navigating Ownership Transitions with Clarity
When business owners plan for succession or unexpected departures, Buy-Sell Agreements play a critical role. Two common structures—Cross-Purchase Agreements and Entity Purchase Agreements—offer distinct approaches to transferring ownership. Understanding their mechanics helps ensure your strategy aligns with your business’s size, goals, and funding capabilities.
🔄 Cross-Purchase Agreements
How It Works
In a Cross-Purchase Agreement, individual owners agree to purchase the ownership interest of a departing partner. Each owner typically holds a life insurance policy on the others to fund the buyout.
Key Features
• Direct Ownership Transfer: Shares are purchased by remaining owners, increasing their individual ownership.
• Policy Structure: Each owner buys, owns, and is the beneficiary of policies on the others.
• Best Fit For: Businesses with a small number of owners (typically 2–3), where tracking multiple policies is manageable.
Considerations
• As the number of owners increases, the number of policies grows exponentially.
• Each owner must qualify for coverage individually.
• Ownership percentages shift directly, which may affect voting rights and control.
🏢 Entity Purchase Agreements
How It Works
In an Entity Purchase Agreement, the business itself agrees to buy back the departing owner’s interest. The company owns and is the beneficiary of life insurance policies on each owner.
Key Features
• Centralized Funding: The business pays premiums and receives proceeds.
• Ownership Transfer: Shares are redeemed by the entity, often reducing outstanding shares.
• Best Fit For: Corporations or LLCs with multiple owners, where centralized administration is preferred.
Considerations
• May affect the business’s balance sheet and equity structure.
• Requires careful coordination with corporate documents and tax advisors.
• Can simplify policy management compared to cross-purchase structures.
🔍 Choosing the Right Structure
When comparing Cross-Purchase and Entity Purchase Agreements, weigh these key factors:
• Number of Owners
• Cross-Purchase: Ideal for 2–3 owners
• Entity Purchase: Scales effectively with larger ownership groups
• Policy Management
• Cross-Purchase: Each owner holds and manages policies on every other owner, which can become complex as headcount grows
• Entity Purchase: The business holds all policies centrally, streamlining administration
• Ownership Impact
• Cross-Purchase: Remaining owners directly increase their individual ownership percentages
• Entity Purchase: The company redeems shares, reducing total outstanding equity without shifting stakes among surviving owners
• Tax Implications
• Cross-Purchase: Buyers generally receive a step-up in basis for acquired shares
• Entity Purchase: No basis step-up for remaining owners—review with a tax advisor for potential consequences
Use these considerations to align your agreement structure with your company’s size, administrative capacity, and long-term objectives.
✅ Action Steps for Business Owners
1. Review your current ownership structure and succession objectives.
2. Evaluate funding options, including life insurance and cash reserves.
3. Consult legal and tax professionals to determine which agreement aligns with your business type.
4. Coordinate with existing Buy-Sell Agreements to ensure consistency and enforceability.
5. Schedule periodic reviews to adjust for ownership changes, valuation updates, or new partners.
Next Week: We’ll explore funding strategies for Buy-Sell Agreements—comparing life insurance, sinking funds, and installment plans to help you evaluate what fits your business best.
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Investment advisory services offered through Redhawk Wealth Advisors, Inc., an SEC Registered Investment Advisor. SEC Registration does not imply any level of skill or understanding. Redhawk Wealth Advisors and Patten Financial Group are unaffiliated and separate legal entities.
