What is it?
The shotgun clause is a common tool in Shareholders’ Agreements that function as follows:
i) Shareholder A tenders an offer to purchase all of Shareholder B’s shares for a specified price per share.
ii) Shareholder B then has the choice of either accepting the offer and selling his/her shares, or rejecting the offer to sell and instead purchase all of Shareholder A’s shares for the same price per share.
It’s the business version of the classic family situation where a parent asks one child to cut the cake and the other child gets to choose which piece they would like.
What are the Benefits?
- The mechanics of the clause generally encourages a “fair” offer price: Shareholder A would not want to pay greater than fair value for Shareholder B’s shares, so would ensure that his/her offer is not too high. Conversely, if the offer price is below fair value, Shareholder B would simply reject the offer and purchase Shareholder A’s shares for that low price. Thus, this will generally result in the offer price being “fair”.
- Owing to the relatively simply nature of the clause, it results in a method for partners to cease their relationship relatively easily and effectively.
- The mere threat of using the Shotgun Clause generally encourages reasonable and productive negotiations between shareholders of the business.
What are the Disadvantages?
If one shareholder has limited financial resources, the other shareholder can take advantage of the situation. For example, if Shareholder B is going through a divorce and has limited financial means, Shareholder A could offer a price well below fair value. Shareholder B would have no choice but to accept the offer since he/she does not have the money to reject the offer and purchase Shareholder A’s shares, even at that low price.
Is it Right for Me?
Shotgun Clauses are relatively simple, and are dangerous in their simplicity. While it’s critical to have a Shareholders’ Agreement in place to allow shareholders a way to exit the business, shareholders should think hard about their own circumstances and whether the risks of the Shotgun Clause are worth it.