Lawyers use shotgun provisions in shareholders agreements way more than they should. Good lawyers recognize when the shotgun is not favourable to their clients.
Shotgun provisions in shareholders agreements work on the cake theory.
You have one slice of cake and two children. One child cuts the slice in half and the other child chooses which piece they want. Since the kid cutting the cake does not know which piece they will get, they try to cut it into two equal pieces.
In a shotgun provision, the initiating shareholder chooses the price without knowing whether they are buying or selling. The receiving shareholder decides whether to buy or sell. If the receiving shareholder says nothing, they have to sell.
Sounds fair. That’s why lawyers use it most of the time. However, it is only fair when both sides are equally able to buy. If the initiating shareholder knows that the receiving shareholder will be compelled to sell, the initiating shareholder can make a ‘low-ball’ offer which values the shares for less than they are really worth.
When will a receiving shareholder feel compelled to sell? When they do not have the money and cannot get the financing. When they are in bad health. When they do not have the ability to operate the business. When age, family commitments or distance make it unattractive to buy. When client loyalties or essential technical skills reside in the initiating shareholder. When they do not have a relationship with the bankers or key suppliers.
So, what can a shareholder in the weaker position do to make the situation fair? (1) Do not agree to a shot-gun provision; (2) Accept a shotgun but insist on a long period of time to decide whether to buy or sell and a long period of time to close. If the shareholder receives an unfair offer, they can use the extended time periods to bring in an investor or financial partner who will recognize the value inherent in the low-ball offer; or (3) Get creative. Perhaps stipulate for a minimum floor price.
What should a lawyer do when a shotgun is proposed? Figure out if it favours their client or the other side. If representing the disadvantaged client, either insist on some other dispute resolution mechanism or restructure the shot-gun provision to remove the other side’s advantage.