Legal Tips and Tricks: “Shotgun Clause”

When trying to separate from a co-founder or partner, shareholders should carefully review the “shotgun” clause in their shareholders’ agreement. Shotgun or a compulsory buy/sell provisions are used in the “it’s you or me” situation when one or more of the shareholders decide that they can no longer proceed with the other(s).

Two Shareholder Shotgun Scenario

Between two shareholders who own shares on a 50-50 split, this is a simple concept. I’ll write you a cheque (possibly fair market value) for all of your shares or you pay me the same value for my shares (Picture one person pointing a shotgun at the other, or the other person wrestling it away and then turning the shotgun at the first person).

It’s automatic: If drafted properly, the mechanism is intended to be automatic, and will include a time limit to accept/reject.

The messaging is “if I don’t hear back from you in a month I’ll assume you have accepted, here’s your money, thanks very much, get lost.”

Point of no return: Once the offer is made, it’s a serious offer and cannot be stopped or revised mid-way, because the targeted shareholders now have the opportunity to “wrestle down” their foes and to turn around the shotguns. If you’re in the “triggering” faction, your shares are immediately at risk of being bought. Of course, any side-deal can be worked about between the parties if all shareholders are able to come to terms.

Multi-shareholder Shotgun Scenario

With many shareholders, the scene is now of one group of people pointing shotguns at another group. Things get more complicated if some people want to wrestle away the shotguns and the other people don’t. This can be handled in two (2) ways:

Pro rata allocation: Acquired shares are usually allocated pro rata as well (or in some other mix if the purchasing shareholders agree) – so that a power imbalance doesn’t inadvertently arise. If any of the acquiring shareholders waive the right to pay for their shares, then the rest of the acquiring shareholders can take up the slack either pro rata for the shareholders who are willing to pay, or in some other mix agreed to between the acquiring parties, so long as all of the shares are acquired and paid for at the full offered price.

In some cases, the shotgun clause requires a certain minimum percentage of shareholding to proceed – so that a 5% shareholder cannot become a 55% shareholder simply because they have lots of available capital.

Make payment on time: Invoking a shotgun clause will create a serious amount of tension so the acquiring party had better have the payment ready. A shotgun clause often includes a penalty so that if payment is not tendered in full, then the non-acquiring parties can acquire the shares of the acquiring parties at a discount.

Often Avoided

The ugly truth about the shotgun clause is that the party with the deeper pockets (rich uncle, more savings) will win in the showdown. This can be heartbreaking if a shareholder is forced out of a company that they had started because they are short of cash, or do not wish to indebt themselves to cover the cash requirement of the shotgun.

If the targeted shareholders are cash-poor, the acquiring shareholders could get a steal of a deal. As mentioned above, a way to avoid this is to require that fair market value, as determined by an independent valuation, be the minimum shotgun offer.

Ultimately, the best way to avoid the shotgun is to get along.

Written by Rajah. Rajah Lehal is Founder and CEO of Rajah is a legal technologist and technology lawyer who is, together with the Clausehound team, capturing and sharing lawyer expertise, building deal negotiation libraries, teaching negotiation in classrooms, and automating negotiation with software.