Monday 1 February 2016

The "Shotgun Clause" - what is it, and is it fair?

The shotgun clause is an often cited tool used in shareholder agreements to provide liquidity to shareholders. This blog post will briefly examine the shotgun clause and discuss some pros and cons.

What is a shotgun clause?

Simply stated, it is a type of buy/sell agreement between shareholders or partners in a business. The shotgun clause is usually added to a shareholders agreement in order to provide shareholders with liquidity in case one wants to exit the business or partnership. It is usually provided as an option of last resort in cases where the shareholders can't agree or have a significant difference of opinion and need to go their separate ways.

A simple example...

Sam and Tom are 50% partners in an incorporated business that manufactures desserts. Sam wants the company to focus on salty treats but Tom disagrees and thinks sweet treats are the way to go. The two shareholders are at an impasse. According to their shareholders' agreement, they are each entitled to call the shotgun clause in cases where they are at an impasse and need to go their separate ways. Therefore, due to his difference of opinion with Tom over sweet vs salty, Sam would like to use the shotgun clause in their shareholder agreement.

As a first step, Sam would need to set an offer price for Tom's shares.

After Sam offers a price to Tom for Tom's 50% of the company, Tom would then have the option of either:
  • accepting Sam's offer or, instead,
  • Tom could buy Sam's shares at the price that Sam had offered for Tom's shares.