The Shotgun and Why It Works

In the last installment of the Blurb, I think I was able to convince you that any corporation with more than one shareholder (‘cept for Ma & Pa situations, maybe) should have a unanimous shareholders’ agreement (“USA”) with a decent buy-sell provision. And now, I will try to convince you that buy-sell mechanism commonly known as the “Shotgun Buy-Sell” (the “Shotgun”) is inherently the best one to use in most cases involving two or three, perhaps four, shareholders.

OK, here it is, two reasons why the Shotgun is best:
  • Lawyers and judges understand shotgun clauses, so they are made to work; and
  • Shotguns are inherently fair, so they do work.

But, let’s talk a bit about what a Shotgun is, and is not thru a. It is marvelously simple, or simply elegant. Let’s say there are two shareholders, Cain holding 60 shares and Abel with 40 out of a total of 100 issued shares. A Shotgun will sometimes provide that the mechanism can’t be used for awhile after the signing of the USA (six months to three or more years) to give the parties a period of time to get used to each other, grow the business, make some money and save the corporation the disruption of civil war. So, in our example, the threshold time has expired. Cain thinks he’s the real talent in the duo, that he’s been carrying Abel, so he decides to get rid of him by pulling the Shotgun on him. He figures Abel doesn’t have the moxy or the contacts to obtain the necessary financing to take him out, so Cain decides to low-ball the purchase price to Abel.

You see, the first step in the implementation of the Shotgun is one party deciding to issue an offer to purchase the other party’s shares. All that the offering party, Cain, has to determine, is the price for his offer, with a twist — whatever price the offering party sets will be the price that the other party, here Abel, can turn around and use in an offer back to Cain! Nifty, isn’t it? Recall that Cain decided to lowball Abel, thinking Abel couldn’t or wouldn’t come back with the counter-offer.

Big mistake, but often done. Underestimating the other side. So, to continue our story, Cain gives Abel a short written offer for say $400,000, knowing full well that Abel’s shares are worth about $800,000. Abel has a fairly short time (7 – 30 days) to consider Cain’s offer, and to either accept it, ignore it (which will be deemed acceptance), or, Abel can turn the Shotgun on Cain, and give him the same price, pro rata, for his shares — which would be $600,000.

If Abel accepts or ignores the offer from Cain, closing of the deal proceeds in a month or two — a very brief time — quicker than a no-fault divorce. That’s it, the ‘partnership’ of Cain and Abel is rendered asunder, Abel gets a cheque and hands over his shares at closing.

However, if Abel is on the ball, he’ll find out quickly enough that Cain has just handed him a great opportunity. By setting a low-ball price, Cain has ensured that Abel will find it really easy to finance the offer back to Cain. So he does. Then the deal is done. Cain must accept the counter-offer from Abel — and now, that’s the end of the game for Cain.

The setting of the price by the original offering party, here Cain, is obviously strategic, a bluff that can be called with permanent consequences. There is no further round of offers. The purchase by Abel of Cain’s shares at the price set by Cain must proceed in short order to final closing. Beautiful, isn’t it?

The price-setting of the Shotgun is the key which ensures fairness — or else. Else the other party says, “Hey, if he thinks that price is good enough for me to take for my shares, then it’s good enough for him to take for his shares”. You know, what’s good for the goose is good for …

The Shotgun is simple: I just described the whole thing above. It forces an offering party to set a fair price, a price that he/she must be prepared to live with as a selling shareholder. The whole thing is over in a couple months. My experience is that even if there are a dozen technical issues left begging in the Shotgun clause or in the offer, the shareholders and their lawyers generally go along with the overall intent to make it happen.

Simple and fair. Who can ask for more than that?