What is a Shotgun Clause and When Is It Useful?
One of the thorniest decisions when starting a new business is deciding in advance what will happen if one of the cofounders wants to leave the business. The difficulty of having this conversation is why many businesses do not decide in advance, but the short-term gain of avoiding an awkward conversation can cause massive long-term losses should a dispute arise later if a partner wants to exit.
One option is colorfully called a shotgun clause (also called a buy-sell clause). A shotgun clause works like this: One partner sets the price for the shares or units in the business. The other partner(s) can either purchase the shares or units from the partner who set the price OR sell his/her/their shares or units to the partner who set the price. Under either scenario, the price is the same and is set by the partner who triggers the option.
A shotgun clause can be a great way to ensure that partners receive a fair price for their ownership interests in the event of a business divorce. Since the partner who triggers the clause does not know in advance whether the remaining partner(s) will exercise the buy option or the sell option, there are incentives under most circumstances to price the shares or units at a fair price. Ensuring that fair price for each partner is the purpose of a shotgun clause.
A shotgun clause is often not a good idea if there are more than two partners in the business as the mechanics become too cumbersome. Also, if there are large differences in the liquidity available to the partners, that can also create a situation where a shotgun clause is not the best option. There are other considerations that should be weighed as well before deciding on using a shotgun clause or any other method for accommodating the desire of a partner to exit a business.
If you are starting a business and wish to discuss your formation options, email us at email@example.com. Each situation is different, so we will analyze yours and determine the best approach for your new business.