Recently a new client asked me to review his company’s Buy Sell Agreement because he and the other fifty percent owner of the company could not stand each other and were suing each other over the ownership of their four year old company that generated $20 million in gross revenue. One man did all the work and the other man had nothing to do with the company other than collect big checks.
The good news was they did sign a Buy Sell Agreement, but the bad news was the agreement was grossly deficient as to the terms and conditions of a buy out and its valuation method was what is called a “shot gun” buy out valuation method. Here is how a shot gun buy out method works:
1. At any time an owner (Owner 1) can notify the other owner (Owner 2) that Owner 1 invokes the shot gun buy out clause.
2. Owner 1 names the buy out price per share (if the company is a corporation) or per membership interest percentage (in the company is an LLC).
3. Owner 2 then has a specified period of time to tell Owner 1 if Owner 2 will be the buyer or the seller at the designated price.
4. Once the buyer and seller are determined the purchase and sale transaction is consummated per the terms and conditions set forth in the Buy Sell Agreement. Hopefully the terms and conditions of the sale are clear and workable.
In my 31 years of experience has a business lawyer who has formed 3,600+ companies I have had very few clients adopt a shot gun buy out clause. The main reason people don’t like this clause is because of the uncertainty it creates. Each owner lives in constant fear that the owner may have financial problems that would give the other owner an incentive to exercise the shot gun buy out clause and name a low price at a time the owner could not come up with the money needed to purchase the interest from the other owner.
I am aware of only had one client who actually exercised the shot gun buy out clause in a Buy Sell Agreement I prepared. It caused the other owner to immediately file a lawsuit to stop the process. This happened at a time when the owners where selling their 20 year old company for $4 million with $2 million on closing and the other $2 million ninety days later. The parties bickered some more then dropped the lawsuit and sold the business.
As for the recent client whose other owner invoked the shot gun buy out clause in their Buy Sell Agreement, the price was $7 million cash and my guy had the choice to buy or sell. He elected to buy. Fortunately for him the company was so successful he was able to borrow most of the $7 million.