Closed Dutch Auctions from Mediator Ralph Williams, III
Ralph Williams August 2009 ADR Tip
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When 50-50 partners break up, the Closed Dutch Auction is an effective way to set the buyout price. The partners exchange sealed bids stating the price at which they will sell their 50% share. The highest bidding partner "wins" and buys out the "loser" at the "loser's" price.
The price set by each partner must be realistic, because if he "loses", the partner will have to sell at the price he set. Setting too low a price has a double adverse effect; the "losing" partner will be the seller at the lower price.
Ralph O. Williams III
ADR: 310.201.0010
Direct: 818.986.8101
Comments (2)
Read through and enter the discussion by using the form at the endmichael webster - August 12, 2009 8:32 PM
Is this any different from the shotgun clause: I name a price, and you decide whether you are a buyer or seller?
Chris Lemens - August 13, 2009 12:29 PM
This seems like it would work well if both parties have sufficient cash to pay the sales price that they would offer. But it does not seem like it would work well if one partner is the financial partner and the other an operational partner with limited other assets (a founder, for example). The operational partner's bid might be lower than the value that he or she would be willing to offer because he or she lacks the financial resources to fulfill the bid as a buyer. So a wise counselor representing an operational partner would insist on financing terms being included in the original partnership agreement. (The shotgun or shoot-out approach has the same problem.)
The shotgun approach results in a higher possible sale price in some situations. Assume that there are two partners, Hi and Lo. Hi is willing to buy or sell at $2m. Lo is willing to buy or sell at $1m. In the closed dutch auction, Hi buys at $1m. In the shotgun approach, there are two scenarios. If Lo makes the offer, then Hi buys at $1m (the same result as the closed dutch auction). But if Hi makes the offer, then Hi buys at $2m.
The closed dutch auction thus gives a comparative incentive for early dissolution to the partner that values the business more, because that partner implicitly gets the difference between the two valuations. Especially in situations where information is not symmetric (e.g., an insider operational partner and an outsider financial partner), that leads to an earlier dissolution of the partnership than under the shotgun approach.
That's not to say that one is better or worse than the other in an absolute sense -- just that they are different, and wise counselors will be sensitive to the differences.