Shotgun Clause: Like the Weapon, Dangerous When Used Wrong.
What Is A Shotgun Clause?
A shotgun clause is a commonly used provision in a shareholder agreement. It is also commonly referred to as a “buy-sell” clause. Essentially, a “shotgun clause” or “buy-sell clause” provides a legal and contractual mechanism for a shareholder “divorce” in the event
that several owners of a company are not getting along. It also creates a form of liquidity in a private company in that it presents a mechanism to allow a shareholder to transfer their shares. Kahane Law Offers custom shotgun clauses in shareholder agreements at a flat rate. Call now for help in Calgary, Alberta 403-225-8810.How Does A Shotgun Clause Work?
In a “shotgun” or “buy-sell” clause one owner can make an offer to the others (either individually, or together) to buy their shares at a certain price per share. Two outcomes then occur. Firstly, the offeror accepts the offer and sells their shares. In this case, the party initiating the sale is forced to sell his or her shares at the price provided in the offer that he or she made to the other shareholders. Alternatively, if the offeror rejects the offer, the offeree buys the shares at the price indicated.
With multiple shareholders the process includes an additional complication. For example, distribution occurs either on a pro rata distribution, or one of the offered shareholders, provided the others consent, and elects to purchase the entire quantity of offered shares.
Without Proper Legal Advice A Shotgun Clause Can Cause Problems
The corporate commercial and start-up business lawyers at Kahane Law Office ensure the proper drafting of your shotgun clause and shareholder agreement. This helps ensure that you understand how it works and also guard against future problems.
Not every ownership structure benefits from a shotgun clause in a shareholder agreement. In fact, there are several problems that a shotgun clause can cause. For example:
- Passive shareholders are much less able to determine the value of the business than active shareholder. This means that the active shareholder(s) have an advantage in negotiations. This situation exists because the passive shareholder has less access to information;
- Both parties run risk of losing their ownership in the company on the cusp of company’s success;
- A wealthy shareholder advantage may exist. For example, they price their offer out of the reach of the other shareholders and yet still less than the shares’ market value;
- A passive shareholder can’t run the company or develop technology without the help of active shareholders. This means that they have no choice but to be bought out. Consequently, they have lower negotiating leverage for a higher share price);
- Numerical superiority principle: It is difficult for smaller shareholders to benefit from a shotgun clause as the amount of money needed to buy out the other shareholders is considerably more than the other way around; and lastly
- The exercise of a shotgun clause can result in simply a form of “shareholder allocation shuffle”. For example, one shareholder makes an offer to purchase to all the other shareholders (5 total). Three of the offered shareholders agree to sell to the offering shareholder. Then, the other two shareholders agree to buy the offeror’s shares pro rata.
Don’t Rely On Boilerplate – Get Proper Legal Advice
To ensure that you don’t fall victim to these clause problems it is critical that you don’t just rely on a boilerplate shareholder agreement or shotgun clause. Get proper legal advice by contacting the corporate and small business start-up lawyers at Kahane Law Office in Calgary, Alberta today at 403-225-8810. We help to draft your shareholder agreement and shotgun clause in line with the context and goals of your business. You can also email us.