As the business evolves, disagreements may arise due to conflicting interests or expectations among team members. With growth, tensions can develop, especially among founders, investors, or employees as they navigate differences in vision or priorities.

This article examines common legal mechanisms that shareholders can agree upon to resolve disputes and ensure business continuity. Understanding deadlock clauses is crucial for founders and investors, providing a framework for addressing disagreements and exit strategies.

Establishing Clear Expectations Early

It is advisable for aspiring founders to align expectations before bringing on new shareholders, particularly before establishing a company. Addressing key issues in clauses such as defining roles, decision-making processes, and strategic direction can help prevent conflicts from arising in the first place.

Deadlock clauses are essential in situations where shareholders cannot agree on critical decisions, especially in a 50/50 ownership structure with equal stakes that can lead to operational standstills.

Casting Vote

During deadlocks in decision-making, typically in tie votes within the board, the board chairperson often holds a casting vote to break the impasse. Usually, a majority shareholder or a lead investor nominee may act as the chairperson in such cases.

“Shotgun” or “Russian Roulette” Clause

The “Shotgun” or “Russian Roulette” mechanism involves one shareholder offering to buy the other shareholders’ shares at a set price. This aggressive approach to a buy-sell agreement requires recipients to either accept the offer or purchase the offering shareholder’s shares at the same price.

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This clause is uncommon in startup shareholders’ agreements due to practical considerations like liquidity requirements for completing the transaction at the shares’ valuations.

Arbitration or Mediation Clause

In the absence of a casting vote or an agreed independent party to resolve deadlocks, an arbitration or mediation clause in the shareholders’ agreement allows for engaging a neutral forum for dispute resolution.

Arbitration mandates settlement by an arbitrator, while mediation encourages facilitated negotiations before litigation. These methods offer an alternative for resolving conflicts while maintaining confidentiality.

Engaging these clauses may involve fees for appointing a mediator or arbitrator and legal representation for the resolution process.

Put and Call Options

Put and call options can force a shareholder buyout in specific situations. A put option allows a shareholder to require another to buy their shares at a predetermined price, while a call option compels a shareholder to sell under defined circumstances.

These options provide flexibility in dealing with disputes, often triggered by events like a shareholder’s death, incapacity, bankruptcy, or breach of contract.

Exit through Sale of the Startup

When disputes cannot be resolved, the shareholders’ agreement may outline a process for selling the entire company. A trade sale involves a third-party buyer acquiring shares, unlocking value for all shareholders.

Drag-along rights may be useful to facilitate the sale without obstruction from dissenting minority shareholders.

Voluntary Winding Up/Liquidation

As a last resort, shareholders may agree to voluntary winding up of the company in irreconcilable disputes. This allows for recovering value from asset sales, although usually at a discounted value.

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Winding up should be a last resort after other dispute resolution methods have failed.

Final Thoughts

Shareholder disputes, especially involving key figures in startups, can impact business stability and continuity. Effective management of disputes requires agreeing on legal mechanisms upfront.

Utilizing mechanisms like casting votes, “shotgun” clauses, put and call options can help founders and investors protect their interests and ensure continuity during conflicts with the guidance of a startup lawyer.

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