What are drag along rights?
A drag along right allows a majority shareholder (ie usually a shareholder holding more than 50% of shares in a company that have voting rights attached) of a company to force the remaining minority shareholders (ie usually a shareholder holding less than 50% of shares in a company that have voting rights attached) to accept an offer from a third party to purchase the whole company.
The majority shareholder who is 'dragging' the other shareholders must offer the minority shareholders the same price, terms and conditions that the majority shareholder has been offered. For example, a majority shareholder who holds 75% of the shares in the company who agrees to sell their shares in a share sale to a potential buyer, must offer the same price for the shares to the minority shareholders if they want to 'drag them along'.
A drag along clause will allow the majority shareholder to 'drag' the remaining minority shareholders with them and require them to sell their shares to the potential buyer at the same price, in order to allow the buyer to purchase the entire company.
Why are drag along rights used?
The aim of drag along rights is to provide liquidity, flexibility and an easy exit route for a majority shareholder. As many buyers of a target company will want 100% control over the business and rarely agree to allow a minority shareholder to retain a minority share, it would be difficult for a majority shareholder to accept an offer if the minority shareholders are uncooperative and block the sale of a company.
Although drag along rights are heavily favoured towards majority shareholders by preventing them from being 'locked in' to the company, these types of clauses also ensure that minority shareholders are treated the same as the majority shareholder.
How are drag along rights triggered?
Drag along rights are triggered in all types of sales transactions such as mergers and acquisitions, or a change of control in the company. The majority shareholder’s percentage of shares is variable depending on the company's ownership mix and the negotiating strength of the shareholders but is normally between 51% - 75%.
Some shareholders, such as venture capital investors or angel investors, may require that drag along provisions are conditional and limited, or contain certain exceptions.
What are tag along rights?
Tag along rights are also known as 'co-sale rights' are the inverse of drag along rights. When a majority shareholder sells their shares, a tag along right will entitle the minority shareholder to participate in the sale at the same time for the same price for the shares. The minority shareholder then 'tags along' with the majority shareholder's sale. Tag along rights are usually worded to state that if the tag along procedures aren't followed then any attempt to buy shares in the company is invalid and won't be registered.
Why are tag along rights used?
Tag along clauses are designed to protect the minority shareholders from being left behind when a majority shareholder decides to sell their shares. If a minority shareholder held 10% of the shares in a company, it would be difficult to sell as most buyers will want 100% of a company. This puts minority shareholders at risk of being forced to sell their shares at a price which is substantially much lower or has no relationship to the actual value of the company. Without tag along rights, minority shareholders may find that they hold unsalable or devalued shares.