Shotgun Buy-Out Transaction

Contact Neufeld Legal PC for corporate transactional and legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

A shotgun buyout is a common form of buy-sell arrangement contained in a unanimous shareholders agreement or partnership agreement, that is capable of resolving deadlocks and facilitating the separation between business partners / shareholders. A shotgun provision is designed to forced the sale of one side's interest in the corporation / partnership, which swiftly and decisively ends the business relationship.

Although the specificity of the shotgun buyout is set out in the controlling legal agreement, the fundamental steps involved in a shotgun are as follows:

• The Offer: One shareholder (the "offeror") triggers the clause by making a written offer to the other shareholder(s) (the "offeree") to either:

  • Buy all of the offeree's shares at a specified price per share.

  • Sell all of their own shares to the offeree at that same price.

• The Response: The offeree then has a limited time to make a decision and must choose one of two options:

  • Accept the offer: The offeree sells their shares to the offeror at the specified price.

  • Reverse the offer: The offeree becomes the buyer and purchases the offeror's shares at the same price.

The core principle is that the offeror does not know whether they will end up as the buyer or the seller. This uncertainty incentivizes them to propose a price that is fair and reasonable, as an offer that is too low could result in them being bought out cheaply, while an offer that is too high could force them to overpay for the other's shares.

Advantages of a Shotgun Buyout

• Dispute Resolution: It provides a clear and predetermined way to break a deadlock between partners who can no longer work together.

• Efficiency: It can be a very quick process, avoiding the time and expense of protracted negotiations or litigation.

• Incentive for a Fair Price: The "you cut, I choose" dynamic is designed to force the offeror to set a fair value for the business.

• Business Continuity: By providing a structured exit, it allows the business to continue operating without being paralyzed by internal conflict.

Disadvantages and Risks of a Shotgun Buyout

• Unequal Financial Power: This is the most significant risk. If one partner has more financial resources than the other, the wealthier partner can use the shotgun clause to their advantage. They can make a low offer, knowing the other partner may not have the financial means to reverse the offer and buy them out. The less wealthy partner is then forced to sell their shares for less than their true value.

• Knowledge Asymmetry: The clause can favor the partner who has a better understanding of the business's true value, especially if intangible assets or market conditions are not fully transparent.

• Lack of Flexibility: It's an all-or-nothing approach with only two options: buy or sell. It doesn't allow for other potential solutions or a more flexible exit strategy.

• Potential for Litigation: Even with a shotgun clause in place, disputes can still arise over the validity of the offer, the valuation of the business, or other terms of the agreement. Strict compliance with the terms of the clause is essential.

Appropriateness of a Shotgun Clause

• A shotgun buyout is most effective in scenarios where shareholders have roughly equal financial standing and ownership stakes. It is less suitable when there is a significant disparity in wealth or knowledge among the partners.

• It is a powerful tool for dispute resolution but is often considered a last resort due to its blunt and high-stakes nature. It is crucial for business owners to carefully consider the pros and cons and to work with legal counsel to draft a clear and comprehensive shareholders agreement / partnership agreement that specifies the terms of the shotgun clause.

When it comes to the legal component of corporate mergers & acquisitions, that is when the law firm of Neufeld Legal P.C. comes into play. Such that when your company is seeking knowledgeable and experienced legal representation in orchestrating and completing business mergers, acquisitions and divestitures, contact us at trong>403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com.