The shotgun clause

Abstract

Purpose

This paper aims to examine the economic rationale for the shotgun clause, a legally specified protocol for the dissolution of a partnership or a private corporation that empowers one investor to acquire ownership of all the venture's assets.

Design/methodology/approach

Employing simple mathematics, the behavior of the initiating party or offeror is modeled in a situation of informational asymmetry and then optimized. The implications of offeror optimal behavior are then examined.

Findings

The paper finds that the introduction of a shotgun clause lowers the offeror's optimal offer price. Whereas in the absence of the clause, the offer price must exceed the offeror's private valuation of the business, in the presence of said clause the offeror's price may not exceed the offeror's private valuation. Situations where the shotgun clause improves versus impairs economic efficiency are delineated. For high (low) offeror private valuations of the business, the shotgun clause induces a greater (lower) discrepancy between said valuation and the offer price. Offerors with high private valuations of the business are shown to prefer the inclusion of the shotgun clause.

Practical implications

The behavioral ramifications of the shotgun clause are presented, thus providing potential partners and private corporation shareholders a guide for the clause's inclusion or exclusion when the small business is structured.

Originality/value

This is the first paper to provide an analysis of the shotgun clause in the context of informational asymmetry, employing refinements and simplifications of extant models that address other small business dissolution procedures.

Citation

Schnabel, J.A. (2008), "The shotgun clause", Journal of Small Business and Enterprise Development, Vol. 15 No. 1, pp. 194-201. https://doi.org/10.1108/14626000810850928