Deadlock can be a serious problem for closely-held businesses. That is particularly true for companies with an even number of managing “votes” such as a 50-50 partnership. Deadlock occurs when a conflict among the owners of a small business becomes so significant that the business is in danger of being unable to carry out its functions, resulting in danger of loss of company assets. In extreme cases, deadlock can lead to death of the company through its judicial dissolution.
For those reasons, many business owners wisely choose to address the deadlock issue before it becomes a problem by contractually agreeing to a resolution mechanism when the company is formed. Typically this is done in conjunction with the preparation of a shareholders’ buy-sell agreement, a partnership agreement or an LLC operating agreement.
One such resolution mechanism has a very “Wild West” feel to it – so much so that it is oftentimes referred to as a “shootout”. Generally speaking, a shootout provision grants a shareholder, partner or LLC member – as the case may be – the right to force either an immediate sale of his interest or purchase of another owner’s interest. The catch: the other party(s) gets to decide whether to be buyer or seller. The shootout works like this: The initiating shareholder “pulls the trigger” by setting the price per share (or unit) when he provides notice to the other party(s). The non-initiating owner(s) would then have a fixed period of time in which to decide whether to sell all of its shares at the stated price, or buy all of the initiating shareholder’s shares at the same price.
The rationale of a shootout is that it avoids the need to obtain a formal valuation of the company since the initiating shareholder has an incentive to price the shares/units fairly. After all, the shareholder doesn’t know whether he or she will be buyer or seller. It also should incentivize owners to resolve issues before deadlock occurs to avoid the risk and uncertainty of a shootout. From a practical standpoint, however, the shootout favors (1) the owner with deep pockets because he or she can afford to be the buyer more readily, and (2) the owner who is better equipped to operate the company because the value of the company diminishes if he or she leaves and the other owner(s) may not have the wherewithal to keep the company successfully operational.
There are several variations of the shootout described above, all of which are designed to avoid the downside risks and consequences of company deadlock. Business owners are free to decide the best way to address the deadlock scenario that best fits their business. The key is to plan ahead. Owners are wise to address these issues contractually when the playing field is level and their interests are aligned – namely, when the business is formed. A well-crafted buy-sell agreement, partnership agreement or operating agreement accomplishes those objectives.
