Relatively few people know about the option of including what is known as a Texas Auction or Shotgun clause in a shareholders agreement. In this article I discuss a few points about them.
They can vary, but in general, how they work is as follows:
- shareholders with (usually) very similar shareholding percentages in a company agree that if they reach a very serious stalemate on shareholder decisions, or they consistently and materially disagree on shareholder matters, or they begin to deeply dislike having to deal with each other, as co-shareholders, there should be some mechanism that forces one of them to buy the shares from the other of them.
- if they agree that this kind of forced share sale arrangement is suitable, they would record it in a written shareholders agreement.
- once the shotgun clause is triggered, one shareholder is entitled to offer a specific price per share to the other shareholder in order to buy that shareholder’s shares. The other shareholder must then either accept the offer and sell its shares, or buy the offering shareholder’s shares at that same price per share. If this other shareholder does not respond to the offer in writing by the due date, he is deemed to have accepted the offer to sell his shares.
- the trigger should be a carefully defined as possible, but this is often difficult to do. Some examples of a trigger could be:
- an irretrievable breakdown of the relationship between the shareholders that is likely to materially and adversely affect the day-to-day operations of the company;
- the failure to pass any resolution which, if not passed if likely to materially and adversely affect the continued existence or financial viability or any material busines of the Company or will render it extremely difficult or impossible to continue carrying on any material business of the Company.
- the idea is that once the process under the shotgun clause begins the parties do not know who will end up being the seller or the buyer of the shares. This means that, they will each put forward a share price for the potential sale or purchased based on fair valuation of the company, and they will not over or under value the company.
- the timeline over which the shotgun clause operates is usually very short. This does however favour parties with cash readily available as raising the finance for a share purchase in a short timeline could be difficult.
- my experience is that the shotgun clause should record each step in its process in as much detail as possible, because a lack of detail just allows a party an opportunity to dispute or delay the process.
- a shotgun clause can also favour a shareholder who has a greater ability to run the company themselves. Such a shareholder can offer a lower price than a shareholder who can not.
- it is no small matter to agree to a shotgun provision, because there is no way to back out of it without the other party’s consent once it is triggered. But in practice, it can be an incredibly valuable and important way for seriously disputing shareholders to terminate their mutual shareholding of one company and part ways, and it can, more importantly, prevent the business of that company from suffering for a protracted period while influential shareholders dispute.