Startup Shareholders’ Agreement: Should I have a Shotgun Clause?

Exercise caution when deciding to insert a shotgun clause into your Shareholders’ Agreement.  Often, for startups, a shotgun clause may do more harm than good.

A shotgun clause forces a shareholder out of the company. By exercising the clause, Shareholder 1 forces Shareholder 2 to either:

• • sell all Shareholder 2’s shares to Shareholder 1 at a set price; or
  • buy all Shareholder 1’s shares at that same price.

those are the only options.  While this might seem an excellent way to remove a founder who is not pulling their weight, there are a number of risks associated with the clause.

1. A shotgun clause may create a perception that there is conflict within the founding team.  Investors invest in a startup’s technology AND the founding team.  An early-stage startup that loses its team has a high chance of failing and, as such, investors want to ensure that the team stays together to protect their investment.  A shotgun clause is a heavy handed way of dealing with disagreements among shareholders and may cause investors to think that the startup team has underlying disagreements that may result in its breakup.   While an investor could simply ask that the shotgun clause be removed, the negative perception created by the clause may push away investors before investment discussions even begin.
2. A shotgun clause may create conflict.  The mere existence of a shotgun clause may exacerbate conflict within a startup team as members know that an extreme solution is always available to solve a disagreement.  By its very existence, the shotgun clause may preclude reasoned negotiation.
3. A shotgun clause may force you out of your company.  Whoever is richest wins with a shotgun clause – if you can’t afford to buy shares, you have to sell.  A shotgun clause could be used by investors to force you out of the startup you founded, given their superior financial means.

If you are seriously considering a shotgun clause in your shareholders’ agreement, ask yourself, “why it is needed?”  If you are not confident in a team member’s commitment then reconsider whether they are truly essential to the company.  Hopefully consideration of a shotgun clause will cause you to consider the makeup of your founding team and, in the long term, create a stronger company.

Solution:  reverse vest all founders’ equity to ensure that key team members remain for as long as needed.