EXIT STRATEGIES FOR SHAREHOLDERS PT. 2 - BUY-SELL CLAUSES

Shotgun Clauses at a Glance

By Delzad Kutky

What is a buy-sell/shotgun clause?

For a quick refresher on exit strategies, take a quick look at the last article in this series. In this article, we’ll go over buy-sell clauses in a Shareholders’ Agreement as an exit strategy. A buy-sell clause is often also referred to as a shotgun clause because of how blunt and aggressive it is as an exit strategy. However, and perhaps ironically, there is a lot of precision, care, and planning required to properly carry out a shotgun exit from a corporation.

The process behind a buy-sell clause essentially allows one shareholder (the “Offering Shareholder”) to set a price per share in the corporation and send a notice to the other shareholder(s) (the “Receiving Shareholder”) forcing them to choose to either buy the Offering Shareholder’s shares at that fixed price, or sell their own shares to the Offering Shareholder at that same fixed price. Regardless of the choice, one of either the Offering Shareholder or the Receiving Shareholder will be bought out, and they won’t have to work with each other anymore.

When is it time to pull the trigger on a shotgun clause?

A buy-sell clause is often used as a last-resort option when shareholders cannot agree on business decisions going forward or simply cannot work with each other anymore. Usually, shareholders will try to resolve their issues another way before starting the shotgun transaction procedure.

Alternative paths including internal negotiations and mediation can offer a path forward where all parties continue to be shareholders and are part of the business. However, if there doesn’t appear to be any reasonable prospect of resolving issues, a well-crafted buy-sell clause gives a shareholder the opportunity to back out of the corporation or to buy out the other shareholder(s) and take the corporation in the direction they want.

When to be wary of shotguns

Shotgun clauses give the outward appearance of being completely impartial. The Offering Shareholder sets a price and the Receiving Shareholder chooses whether to buy or sell at that price. If the Offering Shareholder sets a price per share that the Receiving Shareholder thinks is below market value for the corporation, the Receiving Shareholder can choose to buy out the Offering Shareholder and enjoy the discount. Conversely, if the Offering Shareholder sets a price per share that the Receiving Shareholder thinks is far above market value for the corporation, the Receiving Shareholder can choose to sell their shares to the Offering Shareholder and enjoy the steep mark-up on the shares they sold.

However, the impartiality of the strategy does not mean it is fair or just. The strategy doesn’t take into account scenarios where one shareholder has much more buying power or access to capital than the other(s). A shareholder with limited access to funds can be taken advantage of if their business partner decides to make a shotgun offer. Even if the price per share is less than what they perceive market value to be, the shareholder with less purchasing power may not have the means to buy out the other shareholder and would have no choice but to sell for the lower price.

Negotiating and drafting a buy-sell clause requires careful consideration of your needs and the potential outcomes if you need to exercise your right to make a shotgun offer. The procedure needs to be comprehensive, addressing what happens when there are more than two shareholders, addressing what happens when a shareholder doesn’t respond to an offer or fails to participate at all in a shotgun transaction, and addressing key terms of the shotgun transaction, among other things. A vague or incomplete buy-sell clause can leave room for differences in interpreting what should happen next, which is a common catalyst for contractual disputes.

Furthermore, the procedures in buy-sell clauses usually require specific forms of notices to be prepared and delivered within strict timelines. Failure to follow the procedures properly could make a buy-sell offer void, and leave you stuck in an undesirable situation for weeks or months longer than necessary or even open the door for the other shareholder(s) to counter with their own buy-sell offer on different terms.

Concluding Thoughts

Buy-sell clauses are an excellent tool to help resolve deadlocks and other disputes amongst shareholders in a corporation. However, despite their nickname, they require precision and careful consideration to draft properly and carry out. Moreover, depending on your own circumstances and the financial strength of the other shareholder(s), they may not be the best tool for you to include in a Shareholders’ Agreement. There are also other exit strategies that you may want to include instead of, or in addition to, a shotgun clause. Stay tuned into this article series to read more about other exit strategies.

The knowledgeable lawyers at SorbaraLAW are ready to assist you with planning, negotiating, and drafting your Shareholders’ Agreement to ensure you are protected.