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A cross-purchase agreement is a buy-sell contract between the co-owners of a business in which each owner agrees to purchase the ownership interest of any other owner who dies, becomes disabled, or exits the company. Each owner personally buys out the departing owner's share rather than having the business entity do the purchasing. Cross-purchase agreements are typically funded by life insurance policies that each owner takes out on every other owner.
Think of it like each business partner holding a pre-agreed right of first refusal on the others' shares, backed by insurance money that makes the buyout affordable when the time comes.
In a cross-purchase structure, each business owner owns a life insurance policy on every other owner. When one owner dies, the surviving owners collect the insurance proceeds and use them to buy the deceased owner's shares from the estate. The estate receives cash. The surviving owners receive the departed owner's equity stake. The business continues without disruption.
If the business has three owners, each owner holds two policies on the other two partners. A four-owner business requires each owner to hold three policies. The total number of policies in a cross-purchase arrangement is calculated as n multiplied by (n minus 1), where n is the number of owners. Four owners require twelve policies in total.
When surviving owners buy out a departed owner's shares in a cross-purchase, they do so at current fair market value. That purchase price becomes their new tax basis in those shares. If they later sell the business, they pay capital gains only on the appreciation above that basis.
Under an entity purchase, the surviving owners keep their original lower basis from when the business was founded. All future appreciation above that original basis is subject to capital gains tax when they eventually sell. Over time, this difference can create a substantial tax liability that the cross-purchase structure avoids.
Cross-purchase agreements are most commonly funded by life insurance because the premium cost is predictable and the proceeds are generally received income-tax-free. Disability buyout insurance can fund the agreement in cases of permanent disability rather than death.
Significant differences in age or health between co-owners create premium disparities in a cross-purchase structure. A 40-year-old insuring a 62-year-old partner pays a much higher premium than the reverse. In such cases, the entity purchase structure is often more cost-efficient. Some businesses use a hybrid structure or a trusteed cross-purchase arrangement to address this problem while preserving the tax basis benefits.
With deep roots in traditional finance and the digital asset industry, Acquire.Fi operates as a specialist M&A advisory firm. Coverage spans M&A, secondaries, OTC, and capital markets advisory across digital assets and frontier tech. Our team has decades of combined experience across every stage of the deal lifecycle.
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