Buy-sell and Auction provisions
What is a buy-sell (shotgun) provision? What is an auction provision? When should these clauses be used?
A shotgun provision is a form of buy-sell agreement often used to resolve deadlocks between shareholders of a corporation. Basically, a shotgun provision establishes that one shareholder may make an offer to either buy the shares of the other party or sell his or her own shares at a specific price (the same price whether you are the buyer or seller). The other shareholder is also entitled to choose to either to be the buyer or the seller. The theory with shotgun clauses is that an offeror won't set the price too low because then the other party will be incentivized to buy out the offeror at lower than the market value. They won't set the price too high because then they will overpay to buy out the other party. This theory assumes that both parties are in equal financial positions which may not always be the case.
An auction provision allows shareholders to participate in an auction for the acquisition of all of the other party’s shares. In the auction, bids could be made by both parties, allowing the party with the highest bid to acquire the other shareholder’s shares. At the end of the transaction, only one shareholder must remain.
Both shotgun and auction provisions are used as mechanisms that facilitate the exit of a shareholder from a company, and as such, they are used in the case of deadlocks between shareholders. Both of these buy-sell agreements can be used separately. Shotgun and auction clauses are typically used by shareholders who own their shares 50/50.
It is also possible to recur to the shotgun provision as a first option, and in case of failure, engage in an auction process.