Soon after Bill Perlman founded Phoenix Systems, a $5-million computer-software company in Arlington, Va., 12 years ago, he decided to share equity with key employees, but he wanted to prevent outsiders from one day owning his stock. Perlman ultimately decided to set up buy-sell agreements: legal documents that planned for the transfer of employees' stock back to Phoenix if they died, retired, or were fired.
Buy-sell agreements usually are funded by company-owned life-insurance policies. But there's another alternative: a cross-purchase agreement. According to Valerie Robbins, a partner in the Washington, D.C., accounting firm Beers & Cutler, cross-purchases are different from traditional buy-sell agreements because "each owner -- and not the company -- purchases life-insurance policies to cover his or her proportional share of the value of every other owner's stock."
In companies with multiple shareholders, each owner purchases multiple policies. The face value of each policy is reevaluated every few years, to ensure it reflects an accurate valuation of each shareholder's stock. Typically, corporations reimburse owners for the cost of premiums.
What's the advantage for owners? "The life-insurance proceeds allow owners to avoid the corporate alternative minimum tax, which they might otherwise be subject to if policies were owned directly by the corporation. They're also free from obligation to corporate creditors, a consideration if the company is going through a shaky financial period," notes Robbins. Cross-purchases are structured to help owners reduce their capital-gains taxes and can also help reduce potential estate taxes. But the costs and logistics do get overwhelming for businesses with many owners, such as large law-firm partnerships. For more details, and to see if a cross-purchase agreement makes sense for you, consult your corporate accountant or lawyer. -- Jill Andresky Fraser