Shotgun Clauses in Shareholders’ Agreements: What Are They and How Do They Work?
Updated: Feb 13
This post is not legal advice and is for general informational purposes only. Always speak with a lawyer before acting on any of the information contained herein.
Are you considering implementing a shareholders’ agreement in your business? One of the most important discussions is whether you should include a buy-sell clause. More commonly referred to as a shotgun clause.
To help you decide, we’ve broken it down. To make matters simple, let us take care of the drafting.
WHAT’S A SHOTGUN CLAUSE?
A shotgun clause is a buy-sell provision that forces shareholders to either buy out or sell their shares at a specific price to the shareholder triggering the clause.
Specifically, this clause gives the right to any shareholder to make an offer to the other shareholders to buy their shares for a certain amount of money specified in the notice. If those shareholders refuse, they’re forced to buy the shares of the originating shareholder at the same price and on the same terms.
It’s a blunt tool that needs to be used wisely since, once the clause is triggered, the shareholders only have the option to buy or sell. They must choose one. As a result, a shareholder won’t use this clause if they are not ready for the consequences. Especially since they can be forced out of the company.
This clause can also be used differently. Any shareholder can make an offer to the other shareholders to sell their shares for a price specified in the notice. If the other shareholders refuse, they are forced to sell their shares to the offering partner.
WHEN IS A SHOTGUN CLAUSE USED?
It’s a simple concept that can be lead to incredibly important consequences. It's simple because this is a method to end the relationship between parties with relative ease. As such, it’s most likely used when the business operations are in distress, or there are irreconcilable disputes between the parties.
Despite this, a serious drawback is the difference in the financial position of the parties. An offering party could take advantage of their partner's delicate financial situation. For example, if someone is going through an expensive divorce, the other party might use the shotgun clause offering to buy their shares below the fair market value. Or they could give a short notice period. As a result, their partner will be unlikely to secure a loan from the bank in enough time and will have to accept the offer. This situation can be avoided by negotiating the terms and conditions of the payment at the drafting stage. This is a time when parties are generally getting along and open to being more reasonable.
SHOULD YOU USE A SHOTGUN CLAUSE?
A well-drafted shotgun clause will force all parties to come to a final resolution should the relationships break down. Despite this, you should carefully consider your circumstances. Ask yourself if the risk of having this clause in your shareholders’ agreement is worth it. Connect with us to discuss your situation.