Texas Shootout

What is a Texas shootout?

Texas shootout (Texas shoot-out clause) describes a contractual procedure for separating two equally sized shareholders, in which both bid in sealed form and the highest bidder buys the other's shares. It is triggered by a deadlock in which, because votes are equally divided, neither side can push through a resolution. The bids are opened only once both are in; the highest bidder pays the price of its own bid.

The procedure resembles an auction with sealed envelopes in which there are only two bidders and each is at the same time the seller.

Like the shotgun clause, the procedure appears in shareholders' agreements and in contracts on joint ventures, in each case for companies with two equally sized shareholders. It is used as the last stage after a failed attempt at agreement and ends the partnership: at the end, one side holds all of the shares. The difference lies in price discovery. The price is determined not by one side's offer but by the comparison of two bids.

Course of a Texas shootout

Initiation

The precondition is a contractually defined deadlock, usually after an unsuccessful escalation or mediation stage in which an agreement was first attempted. One side initiates the procedure by notice to the other. Some clauses begin like a shotgun clause with one side's purchase offer; only if the other does not accept does the sealed bidding round follow.

Submission and opening of bids

Both sides submit a binding and unconditional bid within a deadline, sealed, with a neutral body. It is advisable to deposit the bids with a notary, who opens them simultaneously and records the result. The clause specifies what a bid refers to, a price per company share or the value of the entire equity. A bid per share avoids misunderstandings.

Award and completion

The party with the higher bid buys the other's shares at the price of its own bid. For equal bids the clause needs a rule, such as a second round; further variations are also possible but must be expressly agreed. Completion then follows as in a share purchase: notarised assignment, payment and release of shareholder loans and security.

Bidding strategy and economic risks

Each side must determine the value of the company from its own perspective and at the same time estimate how high the other will bid. Anyone who bids far below their own valuation risks being outbid and giving up their shares below that valuation. Anyone who, from fear of losing the award, bids far above pays more than the company is worth to them; this is called the winner's curse.

Financial strength also counts here. The weaker side can bid at most up to the limit of its financing. If the stronger side knows this limit, a bid just above it suffices, even if the company is worth considerably more. Unlike with the shotgun clause, neither side chooses its role afterwards; both commit at the same time.

Robust bids presuppose secured financing, for example a bank's financing confirmation (proof of funds) or a bank guarantee from a guarantee facility. The clause can require that every bid be submitted with such evidence.

Permissibility and form in Germany

Essentially the same standards apply to the Texas shootout as to the shotgun clause. The literature treats both as expressions of the same idea of separation. According to the prevailing view, the procedure is in principle permissible as long as both sides have the same rights. It does not amount to an impermissible exclusion without cause (Hinauskündigung), that is, a one-sided removal of a shareholder without objective reason. With its bid, each side influences whether it stays or leaves. Limits are set, as with the shotgun clause, by the prohibition of arrangements contrary to public policy (Section 138 of the German Civil Code, BGB) and by the objection of abusive exercise.

Because shares must be transferred at the end of the procedure, the clause in a GmbH (German limited liability company) requires notarisation under Section 15(4) of the German Limited Liability Companies Act (GmbHG). Completion requires a notarised assignment. Depending on the design, the bids themselves may also require notarial form. If they are submitted to the notary anyway, this can be combined with the notarisation. For the case that the highest bidder does not pay, the clause needs a follow-on rule, such as the right of the other side now to buy at the price of its own bid. Claims for damages also come into consideration.

Significance in joint ventures and transactions

The procedure is suited above all to joint ventures of two companies with comparable financial strength. In companies with venture capital investors it is unusual. In a company acquisition it becomes relevant in due diligence, the review of the target company before the purchase. If the target company holds a stake in a joint venture with such a clause, the acquirer examines the consequences of the sale. It must be clarified whether the change of control (change of control) can trigger the procedure or gives the partner other rights, such as a right to buy the shares.

Worked example: Texas shootout with bids per company share

Two shareholders each hold 20,000 shares with a nominal value of EUR 1 in a GmbH with share capital of EUR 40,000. The nominal value says nothing about value; it is only the unit into which the share capital is divided. The clause requires bids per share.

• Case 1, bids: A bids EUR 150, B bids EUR 200 per share.
• Award: B buys A's 20,000 shares at EUR 200 each, that is, for 20,000 × EUR 200 = EUR 4.0 million.
• This implies an equity value, that is, a value of all shares, of 40,000 × EUR 200 = EUR 8.0 million.
• For A this means: A receives EUR 4.0 million. With its own bid, A would have paid only 20,000 × EUR 150 = EUR 3.0 million for B's shares. A therefore sells for EUR 1.0 million more than A itself bid.
• Case 2, unequal financial strength: both value the company at EUR 200 per share. A knows that B can finance at most EUR 3.0 million, that is, EUR 3.0 million / 20,000 = EUR 150 per share. A therefore bids only EUR 155 and is awarded the shares.
• A pays 20,000 × EUR 155 = EUR 3.1 million. B receives EUR 0.9 million less than its shares are worth on its own valuation (EUR 4.0 million minus EUR 3.1 million).

How important the reference point of the bid is is shown by a variation of case 1. If A names EUR 6.0 million for the whole company and B names EUR 4.0 million for A's half, A's bid appears higher. Converted, however, A bids EUR 150 per share (EUR 6.0 million / 40,000), B by contrast EUR 200 (EUR 4.0 million / 20,000). The clause must therefore state unambiguously which quantity a bid designates.

Case 2 shows that the Texas shootout does not compensate for a gap in financial strength. Only evidence of financing, sufficient deadlines or a minimum price based on a valuation help against that.

Distinctions: Texas shootout, shotgun clause and right of first refusal

• Shotgun clause: one side names the price, the other chooses whether to buy or sell.
• Right of first refusal: applies when a shareholder wants to sell shares to a third party and gives the co-shareholders the right to buy first on the same terms. It does not resolve a deadlock but regulates the circle of acquirers.
• Auction process: structured sale process in which several external interested parties bid. In a Texas shootout, only the two shareholders bid.

Common mistakes

• Unclear reference point of the bid. If it remains open whether a bid means the price per share, the other's share or the whole company, a dispute over the award is built in.
• No rule for a tie. Without one, the procedure ends without a result if the bids are equal.
• Allowing conditional bids. A bid subject to financing devalues the procedure because it is unclear whether the highest bidder will actually buy.
• Leaving the consequences of non-payment open. If the highest bidder does not pay, without a rule there is no quick route to separation.
• Overbidding from fear of loss. A bid far above one's own valuation secures the award, but at a price that is not economically sustainable.

Frequently asked questions

How does the Texas shootout differ from the shotgun clause?

In price discovery. With the shotgun clause, one side names the price and the other chooses its role. With the Texas shootout, both bid in sealed form and the higher bid decides who buys.

At what price does the highest bidder buy?

As a rule at the price of its own bid. Different rules are possible but must be expressly agreed.

What happens if the bids are equal?

The clause determines this, for example through a second round of bids. If there is no rule, the procedure reaches no result.

What happens if one side submits no bid?

The clause regulates this. A common consequence is that the side without a timely bid must sell its shares at the other side's bid. Without such a rule, one side could block the procedure by doing nothing.

Is the Texas shootout fairer than the shotgun clause?

Not in principle. It prevents one side from choosing the more favourable role afterwards, but equally offers no protection against a gap in financial strength.

The Roemer Capital view

If a client faces a Texas shootout, Roemer Capital works with the client, before the bid is submitted, to develop a robust value range and to clarify up to what amount a purchase can be financed. From both figures follows the range in which a bid is economically justifiable. The decision on the bid is made by the client; legal support lies with the client's law firm.

In sell-side mandates, Roemer Capital checks whether the target company holds stakes in joint ventures with separation clauses. Roemer Capital discloses such stakes to an acquirer early so that they do not become a negotiating issue only in due diligence.