Guest Blog: The “Texas Shoot-Out” for Business Partner Deadlock
October 30, 2019 — What many shareholders, partners, and members forget at the beginning of their new business venture is that planning for the eventual dissolution or termination of the company can be extremely beneficial. One tool that is used as a last resort at the end of a ‘deadlock’ situation is known as the “Texas Shoot-Out.” Though going by various other names, the staple version is the “I cut, you choose” approach.
Like an old western, this process begins when two parties engage in a dispute where neither partner wants to back down.
The “Texas Shoot Out” clause can either be built into the governance documents of an entity or can be used when the partners have failed to provide for a dispute mechanism within those governance documents. A “Texas Shoot Out” is normally saved as an absolute last resort because it fundamentally and permanently changes the entity: one party ends up being bought out with very little room for planning or negotiation.
This process can be triggered through various events or “triggers.” The triggers can be controlled by the parties and may include: a six-month period where the parties cannot agree on the direction of the business, consistent deadlocked votes on a particular business issue, or simply that the partners have vastly differing views about the direction of the company. Generally, one or more of those triggering events are the straw that breaks the camel’s back, and the business partnership has deteriorated beyond repair.
When a shareholder decides they are going to “put their gun up,” the process begins. The first step consists of a shareholder deciding upon a specific price or value for that share of the company. At this point, the non-triggering shareholder has only two options:
(1) Sell his or her share of the company for that price; or
(2) Buy the triggering partner’s share of the company for that price.
This is the “I cut, you choose” mentality; the triggering shareholder “cuts” the business by identifying the price, and the non-triggering shareholder “chooses” to be either the buyer or the seller at that specified price. A somewhat similar analogy can be made to two siblings who are fighting over a final piece of birthday cake. The parent might suggest that sibling #1 “cut” the cake into two pieces, with sibling #2 “choosing” which piece he or she wants.
The rationale behind the “Texas Shoot Out” (and presumably the parent’s decision to have sibling #1 cut the cake and sibling #2 choose the piece) is that the triggering shareholder will attempt to identify a “fair” purchase price. This is because the triggering shareholder does not know whether he or she will be forced to buy or sell at that price. Whatever price the triggering shareholder sets on the table, they must be willing to accept that price in a forced sale. If the triggering party identifies a price that is too low, the other partner would presumably jump at the opportunity to buy. But if the triggering partner’s initial price identification is too high, the triggering partner is forced to purchase at that price.
Though this method is effective in resolving a deadlock, there are several downsides and risks.
First, the time period for resolving a business dispute through a “Texas Shoot-Out” process is generally short. This can cause hasty, emotional, and ill-informed decisions without proper analysis of the actual value of the company, potentially leading to “buyer’s remorse.” Worse yet, since this process is oftentimes a “last resort,” the business has likely been at a standstill for awhile, ostensibly creating an environment where road-weary partners are forced to rush the process in an effort to save the business.
Second, these provisions might favor the wealthier shareholder. Because the timeline is generally short, banks or other entities might not be an option for financing the transaction. As a result, partners often rely heavily on their individual capital to finance the buy-out.
Take, for example, a situation where two partners start a business and one wealthier partner provides the capital while the other “less wealthy” partner provides the services or ideas. In the event they resort to a “Texas Shoot-Out,” the wealthier capital contributing partner has an advantage because that partner might pick a value for the business which that partner knows the “less wealthy” idea partner could not possibly accept, even if that value is lower than a fair market rate for the business. On the other hand, the “less wealthy” idea or service providing partner could not offer a value for the company which he or she could not afford, even if that was the fair market rate for the business. Accordingly, without sufficient capital (or the time to obtain it), the “less wealthy” partner is effectively precluded from meaningful participation in the process.
For those reasons, the “Texas Shoot-Out” resolution of a deadlock is almost always a last resort. Hoping for the best, but expecting the worst may save shareholders extensive headaches when the relationship deteriorates. For those reasons, we typically recommend the “Texas Shoot-Out” only in limited situations and when the risks can be properly understood and assessed. Our experience has shown that business owners are typically better served by creating optional purchase rights for values that are fairly and accurately determined by valuation specialists.
If you have questions or would like to speak with the author, you can reach out to Cole Hickman by clicking here.
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