Cross-Purchase And Redemption Buyouts Compared

Buy-sell agreements come in two basic architectures. Both remove a deceased owner's interest, and they distribute the consequences among the survivors quite differently.

How each structure works

In a cross-purchase, the surviving owners buy the deceased owner's interest personally, using their own funds or funds they have arranged individually.

In a redemption, the company buys back the interest using its own assets, and the remaining owners' proportions rise automatically because fewer interests are outstanding.

The end state looks similar. The route there differs in who pays, who owns what afterwards and what each survivor's investment in their interest becomes.

The basis difference

A cross-purchase gives each buying owner an increased tax basis in the interests they purchased, since they paid for them directly.

A redemption generally does not, because the company made the purchase and the survivors' own basis in their existing interests is unchanged.

That difference is felt later, when a surviving owner sells and finds the gain calculated against a lower basis than the cross-purchase route would have produced.

Funding complexity

Cross-purchase funding scales awkwardly. Each owner must be prepared to buy from every other, so a business with several owners needs a web of arrangements.

Redemption funding is centralised, with a single set of arrangements held by the company, which is administratively simpler and easier to maintain.

Trusteed or entity-held arrangements exist to combine the simplicity of centralised funding with cross-purchase treatment, at the cost of additional structure.

Effects on the company and its creditors

A redemption removes assets from the company at a difficult moment, which can breach lending covenants or leave insufficient capital to trade.

Legal restrictions on a company purchasing its own equity apply in many jurisdictions, typically requiring solvency or distributable reserves, and can block a redemption entirely.

A cross-purchase leaves the company's balance sheet untouched, though the buying owners may borrow personally to fund it and carry that debt themselves.

Effects on ownership ratios

Redemption increases every survivor's proportion equally, preserving the existing balance of control among them.

A cross-purchase allows deliberate imbalance, since owners can buy in different amounts, which is useful where one survivor is intended to take a leading role.

Tax treatment, corporate law limits on redemptions and the mechanics of each route vary by jurisdiction and entity type and change. This is general information; a qualified professional should advise on specifics.