Today, we’ll discuss a specific set of shareholder rights: the drag-along and tag-along rights which may be triggered during the sale of a company to a third party. While drag-along and tag-along clauses are usually in the shareholders’ agreement, they may also be found in the articles of incorporation, or a separate agreement.
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What’s the difference between a drag-along and a tag-along right?
Drag-along rights allow the majority owners of a company to force minority shareholders to accept a deal of the sale of the corporation to a third party. Meanwhile, tag-along rights are the opposite. They give minority shareholders the right to join in an eventual sale by the majority to a third party.
Let’s get into the details.
Drag-along Rights
How it works
For the majority shareholder: This provision ensures the majority stockholders can sell the company under the terms and conditions they want, and “drag” minority owners into the deal even if they do not want to sell.
For the minority shareholder: Drag-along rights force minority stakeholders to sell their shares, usually under the same price and conditions as the majority.
Should you include a drag-along clause in your shareholders’ agreement?
This clause is useful to include where the company has at least one majority shareholder and one or more minority shareholders.
By triggering this clause, the majority can make the minority join the sale even if the latter doesn’t want to sell. The minority’s shares will be sold on the same conditions and for the same price (adjusted according to the position of the minority shareholder) offered to the majority by the third party buyer.
What are the benefits of a drag-along provision?
For third parties: Buying a company becomes more attractive for potential buyers because this clause ensures they can acquire 100% of the control.
For the majority shareholder: May allow the majority shareholder to obtain a higher price for their shares as the acquirer will be getting 100% of the shares in the company.
For the minority shareholder: a well-drafted clause benefits minority shareholders as they will receive the same conditions and price for the sale of their shares.
Tag-Along Rights
How it works
For the majority shareholders: When the majority shareholders decide to sell their shares to a third party, the minority shareholders can join in the sale on a pro rata basis.
For the minority shareholders: Tag-along rights allow the minority shareholders to “tag-along” in the sale of their shares along with the majority so they are not left behind.
Should you include a tag-along clause in your shareholders' agreement?
This provision provides financial and legal protection to minority shareholders in case of a sale. First, by tagging along the majority shareholder the minority stakeholders already have a buyer. Second, by enforcing this clause they do not have to worry about being forced to remain in a company with a new and unknown majority owner.
In some cases, having a tag-along provision may make it more difficult to sell the shares of a company. If a buyer is aware they may have to purchase more shares than they intend, they may hesitate to place an offer.
Keep these provisions in mind when negotiating your shareholders’ agreement. Get in touch with us to discuss the most appropriate structure and clauses for your company.
This blog post is not legal advice and is for general informational purposes only. Always speak with a lawyer before acting on any of the information contained herein.