My client called it the shotgun clause. It’s an exit strategy written into some shareholder agreements, creating a compulsory buy/sell provision when two or more owners can no longer get along.
Here’s how their deal worked (many variations are possible): One owner “triggers” the shotgun clause by offering to buy out their partner at a certain price. The other shareholder must either accept this offer or turn “the gun” around and buy out the triggering shareholder instead, at the offered price. Either way, someone is buying the business and someone is leaving.
Theoretically, the shotgun clause protects the interests of both owners. If one owner decides to trigger the agreement, it’s in their best interest to offer a fair value. If they offer too low, their partner could choose to buy the business themselves, and the triggering shareholder would be bound to accept.
We currently representing a business that’s about a year past execution of its own shotgun clause. As the surviving owner tells it, the break up wasn’t pretty.
They started out as great college buddies. After school, they each started selling on eBay and eventually decided the two of them together could build something great. They entered into a 50-50 partnership did really well for a while. Their business was doing $30 million in sales, with annual increases in sales and profits.
However, 50-50 partnerships can be tricky, and when no one has the ultimate say, disagreements can get ugly. By March of last year, these partners knew they had reached an impasse. My client triggered the shotgun clause and his partner failed to counter. By August it was all over.
In the meantime, this business went through months of limbo in which neither partner was willing to invest in something they might lose. Emotions ran high and neither wanted to do something that might benefit the other.
The business plodded along, and revenues declined for the first time in 10 years. Luckily, the damage was minimal but I have seen it much worse to the point of destroying an otherwise healthy company. Now my client is looking to sell a portion of the business, shrinking it back to a size he’s comfortable managing on his own.
Beware of setting up partnerships in which two or more people have equal ownership and power in decision making. If you do, you need some kind of buy/sell agreement in which one or both partners can get out at a fair price.
No matter how strong your friendship is at the outset, it’s good to plan a “what if” clause if things go sour. As Philip Thurston, a Harvard Business School professor, once wrote, “If you can’t agree on ‘what if’ in advance, don’t start the partnership.”