If you’re a member of a multi-owner business, whether it’s an LLC, a corporation, a partnership, or any other kind of business organization, you absolutely must have a written agreement among the owners.
This is because, among many other considerations, it is almost inevitable that within a few years, serious disputes will arise among the owners, and one or more of these disputes may be unresolvable even among owners who remain friends and who are acting in the best possible good faith.
There are many possible ways of providing for the resolution of these disputes in LLC operating agreements, shareholder agreements and other inter-owner agreements. Two of the most common among two-owner businesses are set forth below.
■The owners’ dispute and the consequences of the dispute will be decided by an arbitrator (perhaps after first being addressed in mediation); or
■Upon winding up the business, the owners will divide its assets equally.
The problem with the above sets of provisions is that they leave the valuation of the business’s assets up to the arbitrator under the first set of provisions and, under the second, to the members at the time of the dispute. However,
■the arbitrator’s valuations may be highly inaccurate in the opinion of one or both owners;
■the owners themselves may be unable to agree on key valuation issues; and
■perhaps worst of all, the arbitrator may decide to resolve the dispute by dissolving the business, or the owners themselves will have to dissolve if they distribute its assets.
However, there is a classic type of contractual provision that resolves all of the above problems and many others that can arise in addressing unresolvable disputes among business co-owners.
It’s called by several different names, but most commonly it’s called a “shotgun” provision.
Under a shotgun provision:
■If a dispute arises among business co-owners about the business that they cannot resolve voluntarily, either of them (the “first owner”) may offer to buy out the other owner on any terms that the first owner chooses. These terms will usually cover the buy-out price; the closing date for the buy-out; any installment payment arrangements the first owner wants; any related interest terms; a penalty provision if the other owner breaches any of the offered and accepted terms; a dispute resolution clause calling for the resolution of disputes about the buy-out by an arbitrator or court; and any useful miscellaneous terms, such as terms that will apply if either party dies before the completion of the buy-out deal.
■The other owner must then exercise one of two choices: either she must accept the terms offered by the first member or she must buy out the first owner on the same terms.
Shotgun provisions are so named because the above offer can be viewed as a shotgun blast:
After the offer is made and implemented, only owner is still an owner.
The premise of a shot-gun deal is that each of the two owners is likely to have a clear and accurate vision of the value of the co-owned business at the time of the dispute, based not only on the assets and employees of the business– which both owners will know intimately – but also on competitive considerations and considerations of the current and future condition of the local and national economy.
In my experience, this premise is very often valid. I’ve seen many arbitrator appraisals of businesses in connection with owner disputes that were patently wrong, but the owner evaluations I’ve seen have generally seemed to me to be remarkably accurate.
Furthermore, in formulating the terms of a shotgun offer, the first owner will always be acutely aware that instead of being the buyer, she may very well be the seller. I can imagine no other impetus as likely to inspire the first owner to ensure that the terms she offers to the other owner are as fair and reasonable as possible.
Finally, a shotgun provision in an owner agreement has the often-substantial advantage of preserving the business of the co-owners and ensuring that the business is managed by an experienced and motivate manager. And it obviously offers major advantages to non-owner employees.
There is, however, one major danger in a shotgun provisions – namely, that it may favor the first owner if she is significantly wealthier than the other owner and thus is better positioned to buy out the other owner if the other owner cannot afford the first owner’s terms. In this situation, the wealthier owner may even be willing to offer the less wealthy owner a buy-out premium because the wealthier owner believes that, in the long term, the premium will make sense. And it is possible that the wealthier owner may exercise a shotgun provision offer at a time when she knows it will be particularly hard for the less wealthy owner to refuse – for example, when a member of the less wealthy owner’s family incurs a costly illness.
But there are, in my experience, solutions to the above problems that can often be highly effective. The first is that, obviously, the less wealthy owner can always decline a proposed shotgun provision. The second is more complex but, in many situations, may make sense – namely, that if either party thinks a proposed shotgun offer, when made, is unfair to the offeree, she can challenge the unfairness in arbitration. And to give added teeth to the arbitration, the arbitration terms can provide that the loser of the arbitration must pay the arbitration costs of the winner.
In short, shotgun provisions aren’t for everyone. However, for many business co-owners, they’re the best available way to resolve owner disputes.
(John Cunningham is a Concord, NH lawyer of counsel to McLane Middleton, P.A. His practice is focused on LLC formations, general business and tax law, advising clients under IRC section 199A, and estate planning. His telephone number is (603) 856-7172, his e-mail address is lawjmc@comcast.net, and the link to his website is www.llc199A.com.)