Entity Purchase Agreement vs. Cross-Purchase Agreement

When it comes to future business succession planning, Entity Purchase agreements and cross-purchase agreements are the two best options. Both agreements have the same focus: to protect your business in the event the owner leaves or expires. 

In this post, we will discuss the differences between these two agreements, explore three advantages and disadvantages, and see which one best suits your business. 

What Is an Entity Purchase Agreement?

An entity purchase agreement is a succession plan for businesses with multiple owners. When a business partner decides to leave the firm for any reason, the entity purchase agreement comes into play and ensures that the business itself buys the share of the departing partner instead of the other owners. To make this a viable option, companies take out insurance policies as per the shares of each owner in the company to fund it.  

The plan works this way: The firm purchases insurance equal to every owner’s share. If their one’s share is $500k, then their insurance will be for the same amount. This way, each partner has a sound financial plan for the business and their families when they leave. 

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What Is a Cross-Purchase Agreement?

A cross-purchase agreement is also a succession plan for businesses with multiple owners. In this agreement, the existing partners buy out the shares of the departing owner. In this agreement, the partners take out insurance policies on each other, so when someone leaves, others use that insurance money to fund the departing members’ shares. 

This is how it works: Suppose a business has three members- A, B, and C. A buys insurance for B and C, B buys the policy for C and A, and C buys it for A and B. This way, when someone leaves, the other two will use the insurance amount to buy out the share of the departing one. This plan is suitable for businesses with fewer owners. With fewer owners, it becomes easier to keep track of who is to take insurance on whom. 

Entity Purchase Agreement vs. Cross-Purchase Agreement

Who Buys the Shares?

The main difference between the two agreements is who is responsible for buying the shares of the departing partner. For an Entity Purchase agreement, the company is responsible for buying out the share of the departing partner. On the other hand, for a cross-purchase agreement, all the remaining partners are responsible for buying the share of the departing owner. 

Life Insurance Policies

The insurers are different in both contracts. For the Entity purchase agreement, the company itself is responsible for taking out insurance on each owner. Meanwhile, for the Cross-purchase agreement, every owner is responsible for taking out insurance that will insure one of the owners. 

Simple Vs. Complex

In an entity purchase agreement, the business is responsible for insuring and buying the share at the end, making it simple for the partners. They don’t have to oversee much here, even if there are many owners for the firm. 

Things are different in a cross-purchase agreement. Every owner is responsible for taking out insurance for others, and all are supposed to buy out the share of the departing member when the insurance payout is received. This makes it a very complicated system. Even the owner’s responsibilities are immense compared to an entity purchase agreement. And the more firm owners there are, the more complex it becomes to handle. 

Tax Implications

Here is where cross-purchase gains the upper hand. When it comes to an entity purchase agreement, the contract is subject to corporate taxes, which can reduce the insurance payout. But for cross-purchase, it is a tax-free contract as it is personal insurance. 

When to Choose an Entity Purchase Agreement

An entity purchase agreement is more suitable for a larger business with many owners/partners. It’s also suitable for partners who want to outsource managing the whole buying-out process to the company itself. This means the company’s management will be responsible for buying every owner’s insurance and handling the payout later. With the company handling the whole process, it makes it easier for owners to focus on other things. 

This contract is ideal for companies that want complete control over ownership transitions. It is also the perfect option for businesses that want to avoid conflict when someone leaves. 

Best for: 

• Firms with many partners. 
• Firms that want to outsource the process and hassle. 
• Owners who want to manage the buy-out transition themselves. 

When to Choose a Cross-Purchase Agreement

A cross-purchase agreement is suitable for smaller businesses with fewer partners. In this agreement, each partner is responsible for taking out life insurance for other partners, which makes it ideal for businesses with 2-3 partners. This contract ensures that the company doesn’t get involved in the process, and the remaining owners can buy out the departing partner’s share directly. 

This contract is perfect for small businesses because it helps avoid taxes. In this case, the owners buy personal insurance, which is tax-free. This contract is for those owners who want to manage and direct the complete buyout process. 

Best for:

• Small businesses with less number of owners. 
• Owners who want to manage the buyout process among themselves. 
• Business owner’s looking for a tax-free method. 

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FAQs

Final Statement

Deciding between an entity purchase agreement and a cross-purchase agreement depends on the business partners and its structure. For larger businesses with multiple partners, an entity purchase agreement is more suitable due to its design, which sets the complete buyout process’s management pressure aside for the company. Small businesses with fewer partners can benefit more from a cross-purchase agreement, which gives them more power over the complete buyout process and tax benefits.