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I don't understand the "shotgun clause" at all. Suppose we simplify and the offer must be accepted using only money in a (private) bank account designated in a

I don't understand the "shotgun clause" at all. Suppose we simplify and the offer must be accepted using only money in a (private) bank account designated in advance, and each person knows the other person's balance because they're honest with each other. Then if one person has $27,000 in their private bank account and the other person has $14,000 then the person with $27,000 can offer $14,001 and the person with $14,000 is forced to accept. If one of the parties happens to be overdrawn on that account and have net -$3.70 then the other party can ofer $5 and the overdrawn party would be forced to accept. Now granted in the real world people can raise buyout capital from their private network on short notice -- but doesn't this show great unfairness, if the parties aren't both independently much richer than the value of the business they're discussing? For most startup founders who own, say, 50% of a startup whose last valuation was $7 million, that is nearly all of their net worth. The vast majority probably could not so much as raise $50,000 on short notice. So, if one of the parties already has a hundred thousand, they can offer $55,000 and the more cash-strapped party would be forced to accept it. So what gives. I just don't get it at all. Like, I don't even get the theory of why this is supposed to be fair... it just seems "obviously" broken to me -- so I must be missing something.

beagle3 9y ago
You are missing the "raising for buy out". If the shares are realistically worth $20K, and the $27K guy offers $14.1K, then the $14k guy would raise $0.1K (possibly even with a 50% APR) and counter; instant 5.9k profit.
- logicallee 9y ago
  It was an illustrative, mathematical example, of what I'm talking about. If the shares are worth $3.5 million, how much do you think the guy leaving can raise on short notice? If you say anything over $100,000 you are delusional. Investors don't even see the value in companies that are provably worth $1 billion. Even in retrospect you say, "well yeah history showed it is worth $1 billion, and the founder made a good case for that, but actually that is like a founder making a good case that he will role 10 "6's" in a row on a die, and then proceed to do that. The chances that he was going to do that are actually just 1 in 60,466,176 so the correct value of that "$1 billion" share is actually $1 billion / 60,466,176 = $16. That seems a little low - I'll give you a $100 for it. That's my annual budget for lottery tickets." Investors don't value startups correctly and the idea that a guy can quickly raise money for a buyout of a stake in a company he's leaving borders on delusional. Plus, who would invest in a company with a negative signal that strong: that a guy who owns 1/3 of it wants to leave it. There is obviously absolutely no way for a cash-poor founder without prior exits to raise anywhere near $3.5 million for a 50% buyout of a company raising a round at $7 million. honestly - have you tried raising money around the seed stage? It's brutal, if everyone is on board and there are no negative signals of any kind. I wouldn't be surprised if no poorly networked, cash-poor founder has raised significant (>$1 million) for a shotgun buyout of a company he's leaving, on short notice, ever. I might be wrong though, and I'd love to know if so. In my model it's really, really hard to raise money.
  - beagle3 9y ago
    Yes, I have raised successfully at the seed stage several times. If the company is worth $3.5M and no vesting schedule, no investor will touch it (and the 3.5m valauation was reached either out of thin air, or on the back of a sucker). If you cannot raise (with e.g. 20% discount for the trouble), the valuation is wrong.
    - logicallee 9y ago
      I think we're saying the same thing. The example wasn't of raising a round - it was raising money for a shotgun buyout, so you can leave a company completely while the company tries with other principals and other investors. Using your money - but not using the guy you're giving your money to, who will go home. That's the scenario that I don't think is very realistic. As a result the poor founder will not be given a fair offer. Which is why I don't get how shotgun clauses are supposed to be fair. This is pretty "obvious" to me. So I might still be missing something.
      - beagle3 9y ago
        No, we are not saying the same thing. I say that the situation you described is so far fetched as to be irrelevant to a discussion of "shutgun buyouts" in general. How did the company reach a $7M valuation? They might have sold 1 share out of 7M shares for $1. That, technically, would make it worth $7M. But practically, it isn't. Let's say company raised $3M at $4M pre-money => $7M post money. That's not unreasonable. At this point in time, the company has $3M in the bank, so it is indeed worth at least $3M. Let's say "cash poor founder" only has $100K in the bank. If "cash rich founder" offers to buy 50% for $500K (five times what "cash poor founder" can afford), then it is extremely easy to raise $500K, for a promise to pay $550K from company coffers the next day, because in fact those $500K will buy control of $3M. And that's exactly why investors insist on vesting schedules, first rights of refusals, tag-alongs, bring-alongs, etc - because the investor who put $3M into that company is likely to lose it in a variety of real world cases without those clauses. I say your cases are not impossible, just extremely improbable. In practice, it is easy to borrow against a grounded valuation with some. The poor founder will likely get an "unfair" offer, but "unfair" here is within 10-20% of a fair offer, not a 50% or 90% as in your examples. I assume poor founder is a smart founder, of course - he might not have access to lenders/investors, which could get him treated unfairly; But of course, that's also the case for having illness, immigration problems, disability, etc. Money is an advantage, lack of money is a disadvantage -- but it is not fatal in these cases in general.
BrentOzar 9y ago
> Then if one person has $27,000 in their private bank account and the other person has $14,000 then the person with $27,000 can offer $14,001 and the person with $14,000 is forced to accept. Not necessarily - for example, in my own company's case, the company itself paid out the other partners. The company can take on debt to buy out a partner's shares (or a portion thereof) if the existing partners are willing. I couldn't have afforded to buy out my partners personally, but with the business's assets, I could.
- logicallee 9y ago
  Hey, this is very useful information. I would like to ask some more details, but not here. Could you throw up a contact on your profile or mail me at mine, if you'd have a couple of minutes for my questions around that? Thanks.
  - BrentOzar 9y ago
    Absolutely, YGM.
bsterne 9y ago
There are financing options for people facing a shotgun clause. e.g. http://www.shotgunfund.com/ http://www.shotgunfund.com/
- logicallee 9y ago
  OMG, I'm not in that position or anything right now but thank you SO much for this link! So good to know.

beagle3 9y ago

You are missing the "raising for buy out". If the shares are realistically worth $20K, and the $27K guy offers $14.1K, then the $14k guy would raise $0.1K (possibly even with a 50% APR) and counter; instant 5.9k profit.

logicallee 9y ago
It was an illustrative, mathematical example, of what I'm talking about. If the shares are worth $3.5 million, how much do you think the guy leaving can raise on short notice? If you say anything over $100,000 you are delusional. Investors don't even see the value in companies that are provably worth $1 billion. Even in retrospect you say, "well yeah history showed it is worth $1 billion, and the founder made a good case for that, but actually that is like a founder making a good case that he will role 10 "6's" in a row on a die, and then proceed to do that. The chances that he was going to do that are actually just 1 in 60,466,176 so the correct value of that "$1 billion" share is actually $1 billion / 60,466,176 = $16. That seems a little low - I'll give you a $100 for it. That's my annual budget for lottery tickets." Investors don't value startups correctly and the idea that a guy can quickly raise money for a buyout of a stake in a company he's leaving borders on delusional. Plus, who would invest in a company with a negative signal that strong: that a guy who owns 1/3 of it wants to leave it. There is obviously absolutely no way for a cash-poor founder without prior exits to raise anywhere near $3.5 million for a 50% buyout of a company raising a round at $7 million. honestly - have you tried raising money around the seed stage? It's brutal, if everyone is on board and there are no negative signals of any kind. I wouldn't be surprised if no poorly networked, cash-poor founder has raised significant (>$1 million) for a shotgun buyout of a company he's leaving, on short notice, ever. I might be wrong though, and I'd love to know if so. In my model it's really, really hard to raise money.
- beagle3 9y ago
  Yes, I have raised successfully at the seed stage several times. If the company is worth $3.5M and no vesting schedule, no investor will touch it (and the 3.5m valauation was reached either out of thin air, or on the back of a sucker). If you cannot raise (with e.g. 20% discount for the trouble), the valuation is wrong.
  - logicallee 9y ago
    I think we're saying the same thing. The example wasn't of raising a round - it was raising money for a shotgun buyout, so you can leave a company completely while the company tries with other principals and other investors. Using your money - but not using the guy you're giving your money to, who will go home. That's the scenario that I don't think is very realistic. As a result the poor founder will not be given a fair offer. Which is why I don't get how shotgun clauses are supposed to be fair. This is pretty "obvious" to me. So I might still be missing something.
    - beagle3 9y ago
      No, we are not saying the same thing. I say that the situation you described is so far fetched as to be irrelevant to a discussion of "shutgun buyouts" in general. How did the company reach a $7M valuation? They might have sold 1 share out of 7M shares for $1. That, technically, would make it worth $7M. But practically, it isn't. Let's say company raised $3M at $4M pre-money => $7M post money. That's not unreasonable. At this point in time, the company has $3M in the bank, so it is indeed worth at least $3M. Let's say "cash poor founder" only has $100K in the bank. If "cash rich founder" offers to buy 50% for $500K (five times what "cash poor founder" can afford), then it is extremely easy to raise $500K, for a promise to pay $550K from company coffers the next day, because in fact those $500K will buy control of $3M. And that's exactly why investors insist on vesting schedules, first rights of refusals, tag-alongs, bring-alongs, etc - because the investor who put $3M into that company is likely to lose it in a variety of real world cases without those clauses. I say your cases are not impossible, just extremely improbable. In practice, it is easy to borrow against a grounded valuation with some. The poor founder will likely get an "unfair" offer, but "unfair" here is within 10-20% of a fair offer, not a 50% or 90% as in your examples. I assume poor founder is a smart founder, of course - he might not have access to lenders/investors, which could get him treated unfairly; But of course, that's also the case for having illness, immigration problems, disability, etc. Money is an advantage, lack of money is a disadvantage -- but it is not fatal in these cases in general.

BrentOzar 9y ago

> Then if one person has $27,000 in their private bank account and the other person has $14,000 then the person with $27,000 can offer $14,001 and the person with $14,000 is forced to accept. Not necessarily - for example, in my own company's case, the company itself paid out the other partners. The company can take on debt to buy out a partner's shares (or a portion thereof) if the existing partners are willing. I couldn't have afforded to buy out my partners personally, but with the business's assets, I could.

logicallee 9y ago
Hey, this is very useful information. I would like to ask some more details, but not here. Could you throw up a contact on your profile or mail me at mine, if you'd have a couple of minutes for my questions around that? Thanks.
- BrentOzar 9y ago
  Absolutely, YGM.

bsterne 9y ago

There are financing options for people facing a shotgun clause. e.g. http://www.shotgunfund.com/ http://www.shotgunfund.com/

logicallee 9y ago
OMG, I'm not in that position or anything right now but thank you SO much for this link! So good to know.