While Shareholders Agreements can be complex and full of legal jargon, one provision that’s worth understanding is the “shotgun clause.” It’s not quite as exciting as it sounds (sorry, cowboys), but it can be a valuable tool in resolving disputes between shareholders.
What is a Shotgun Clause?
A “Shotgun Clause” is a provision commonly included in shareholders agreements to provide a mechanism for shareholders to resolve a deadlock in ownership or management of a company.
Also known as a buy-sell provision or an auction provision, it is a type of dispute resolution clause that may be included in shareholder agreement. In essence, it allows one shareholder to make an offer to buy out the other shareholder(s) at a fair price, which the other shareholder(s) must either accept or match in order to buy out the initiating shareholder.
While it may sound a bit like a Wild West standoff, a shotgun clause is actually a helpful way to resolve disputes quickly and fairly. It’s often seen as a last resort when all other attempts to resolve the dispute have failed. Think of the shotgun clause as a “breakup plan” for business partners (like a prenup for your business relationship).
How does a Shotgun Clause work?
If the partners can’t agree on something big – like the future direction of the company, they can turn to the shotgun clause to settle the dispute.
One partner can “shotgun” an offer to the other to buy their share of the business at a certain price. The other partner can then choose to buy them out at that price…. or offer to buy the first partner’s share for the same price. They go back and forth until they finally agree on a price. It’s like a game of “you buy me out, or I buy you out” with strict rules.
For example…
Let’s say two business partners, Alice and Bob, each own 50% of a company. They’ve included a shotgun clause in their shareholder agreement, which states that if one partner offers to buy out the other partner’s share, the other partner has the option to either sell their share at the same price or buy out the first partner at the same price.
One day, Alice decides she wants out of the business and offers to buy Bob’s share for $100,000. Bob can either accept the offer and sell his share to Alice for $100,000, or he can use the shotgun clause to force Alice to either sell her share to him for $100,000 or buy his share for $100,000.
If Bob decides to use the shotgun clause, Alice would then have to choose whether to sell her share to Bob for $100,000 or buy Bob’s share for $100,000. Alice would likely carefully consider her options and decide which one is more financially advantageous to her.
Of course, Alice’s decision would ultimately depend on a variety of factors, including her personal financial situation, her goals for the business, and her expectations for its future performance.
Should you include a ShotGun Clause in your Shareholders Agreement?
Sure – but keep in mind that while a shotgun clause can be a useful tool in a Shareholders Agreement, it is important to ensure that it is drafted carefully and takes into account the specific circumstances of the company and its shareholders. You don’t want to end up shooting yourself in the foot, so to speak.
For example, it may be necessary to include specific provisions around how the price for the buyout is determined, to ensure that it is not triggered too easily or to ensure that minority shareholders are adequately protected.
It’s also important to keep in mind that it may lead to one shareholder having a disproportionate amount of control: If one shareholder has significantly more resources than the other, they may be able to buy out the other shareholder using the shotgun clause, which could lead to them having an unfairly high level of control over the business.
In conclusion, while a shotgun clause may not actually be as exciting as it sounds, it can be a useful provision for you to include as a dispute resolution mechanism in a shareholders agreement. Just make sure to work with legal professionals to ensure that it’s tailored to the specific needs of your business and stakeholders (and that it’s enforceable should you ever need to pull the trigger).
If you are after some helpful resources – here’s our most popular picks!
📖Buy Grow Exit (lucky you – click here for a bonus 20% OFF before 31st March 2023)
🎙️The Deal Room Podcast – be sure to subscribe to hear the latest tips, tricks and traps from buyers, sellers and business brokers.
Joanna Oakey, the author of Buy Grow Exit, is the founder and Managing Partner of the commercial law firm, Aspect Legal and host of the successful business podcasts Talking Law & The Deal Room. She brings decades of experience-based insights from working with business owners (and their advisors) on acquisitions, exits, and general commercial legal matters.
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