How do Drag Along Rights Work?
- For majority shareholders: Drag-along provisions help ensure majority owners can sell the company when and how they want, and “drag” minority owners into the deal even if the minority owner does not want to sell.
- For minority owners: Drag-along rights force minority owners to sell their shares, but usually at a price and on terms equal to the majority. ...
What is drag along rights in law?
A drag-along right is a right that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price and terms and conditions as any other seller. ... Drag-along rights are designed to protect the majority shareholder.
What does drag along mean in a contract?
A drag-along right is a provision or clause in an agreement that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller.
What are drag-along rights in shareholder rights?
What Are Drag-Along Rights? A drag-along right is a provision or clause in an agreement that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller.
What is the difference between a tag along right and drag along?
A tag along right gives optional opportunities to minority shareholders and a drag along protects the plans of key shareholders. They are both designed to serve completely different purposes, whilst having a similar outcome of finding a buyer for the entire company.
How do you invoke drag-along rights?
In most cases, drag-along rights may only be invoked by the majority shareholder where the transfer to the third-party purchaser is for cash consideration. Where the drag provision will apply equally to transfers for non-cash consideration, this may be met with strong resistance from the minority shareholders.
Can you have both tag along and drag-along rights?
For example, even if you disagree about at what price the majority is selling their shares, you might be dragged along to sell at the same price. If your co-owner wants to tag along with your sale, he or she can do so as well.
Are drag-along rights standard?
However, the owner must usually offer the same terms and conditions to the minority shareholders as to the majority shareholder(s). Drag-along rights are fairly standard terms in a stock purchase agreement.
Where can I find drag-along rights?
Sometimes known as “bring along rights” or “drag rights,” these provisions are usually found in the term sheet and subsequent shareholder's rights agreement, if included in a deal. In venture capital, the majority shareholders can either be the investors or the founders—it typically depends on the company's stage.
What is the difference between drag along and tag-along rights?
Whereas tag-along rights give minority shareholders negotiating rights in the event of a sale, drag-along rights force the minority shareholders to accept whatever deal is negotiated by majority shareholders.
Can a shareholder be forced to sell shares?
In general, shareholders can only be forced to give up or sell shares if the articles of association or some contractual agreement include this requirement. In practice, private companies often have suitable articles or contracts so that the remaining owner-managers retain control if an individual leaves the company.
WHAT ARE LLC drag along rights?
A standard clause in many LLC agreements, a drag-along provision gives a majority member wanting to sell to an unrelated third party all or a substantial percentage of its membership interests in the company the right to force the other members to also sell all or a portion of their membership interests to the third ...
Can a minority shareholder block a sale?
A minority shareholder typically can't block a sale on their own unless: They have the support of enough minority shareholders to overcome the will of the majority; or. The contracts or applicable law require that all shareholders vote in favor; or.
What happens when a major shareholder sells?
When a major shareholder sells a large number of shares, it may cause the value of the company's stock to fall, because stock prices are determined by the supply and demand for the stock and the sale of a large number of shares creates a sudden increase in supply.
What are piggyback rights?
Piggyback registration rights, where the investor is entitled to register its securities when either the company or another investor initiates the registration. Holders of piggyback rights are allowed to include their securities in a registration initiated by the company or another investor.
Can a minority shareholder sell their shares?
Minority shareholders can still sell their stock in the future to make a profit if the investment is healthy, and can still reap the dividends that the business awards. These benefits do not go away because of the status of the shareholder.
How does tag along work?
Tag-along clauses operate to protect minority shareholders when majority shareholders sell their shares. The tag-along clause allows minority shareholders to force majority shareholders to get the same sale terms and price for the minority shareholders as a condition of selling the majority shares.
What is drag along rights?
Drag Along Rights (also referred to as “drags” or drag-along provisions) are rights that give the majority owners the right to force minority owners to join in the sale of a company. The rights give the majority owners the ability to sell the entire company based on the terms and conditions. Definitive Purchase Agreement A Definitive Purchase ...
Why is the drag along right not enforceable?
The judge held that the drag along right was not enforceable because the majority owners failed to comply with the drag along sale provisions contained in the governing agreement. The majority owners only notified the minority owners of the drag along sale after it had already occurred. The governing agreement required that ...
What is the logic behind the drag along?
The logic behind the “dragging along” is that the majority owners have negotiated with the minority shareholders that the former has the right to sell the company, regardless of the form in which the sale is to occur. In the absence of drag along rights, minority shareholders may object to the sale of the company.
What is the drag along clause in a company sale?
The goal of the drag along sale is to help eliminate the minority owners or bring them to the negotiating table and get them to agree to sell the company to potential buyers. Both parties – the majority and minority owners – approach the negotiating table with caution since the drag-along provisions implicate their rights in a future sale transaction. The logic behind the “dragging along” is that the majority owners have negotiated with the minority shareholders that the former has the right to sell the company, regardless of the form in which the sale is to occur. In the absence of drag along rights, minority shareholders may object to the sale of the company.
What can a majority owner do to a drag sale?
Another remedy that the majority owners can take is to agree with other parties to add provisions to the governing document requiri ng the company to automatically update its records to reflect the ownership transfer of a drag sale transaction. The governing documents may include a clause that requires the sales proceeds of a drag sale to be held in trust by a third party until the minority owners comply with the sale obligations. These provisions will force the minority owners to give up their ownership control interests to get a share of the sales proceeds.
What is a drag along transaction?
From the majority owner’s perspective, a drag along transaction can be triggered by all types of sales: mergers, the sale of substantial assets of the company , sale of company securities, and acquisitions . In most cases, companies include drag along rights in the definition of “transfer”. For example, the term “transfer” may be modified ...
What can a majority owner do?
The first remedy that majority owners can take is to request minority owners to grant an irrevocable proxy. If given, this allows majority owners to act on behalf of minority owners in any vote or action required to effect the sale. It includes signing documents on behalf of the minority owners. However, the majority owners must still comply with the appropriate statutory requirements while acting on behalf of the minority owners.
What is drag along right?
A drag-along right, drag along provision, or bring along right, is a right that gives majority investors the ability to sell a company to a third-party without consent from minority shareholders. This helps protect the majority and eliminate the minority. However, minority shareholders still receive an equal sales price, terms, ...
Why Is a Drag-Along Right Important?
Because of the desire for complete ownership, a drag-along right facilitates the sale between companies. For example, a CEO of a startup may negotiate a drag-along clause during investment negotiations. This protects the CEO if someone wants to buy the firm later, as well as giving them a majority stake. It should be noted that a drag-along right that allows investors to force a sale is in some cases a detriment.
Why did the court side with the minority?
Also, the court sided with the minority because the majority failed to exercise the drag along properly, as it didn't tell the minority of the transaction beforehand.
What percentage of stockholders can vote on a drag-along?
In most cases, the controlling majority, or a minimum of 51 percent are allowed to hold a vote to trigger a drag-along the sale. However, 66 percent may be the ideal rate depending on the company. Voters are usually preferred stock holders. Common stockholders might also be included, but this is rarer.
What is appraisal rights?
Appraisal rights are the right of a minority shareholder to petition the court for a fair value of their shares. To keep their appraisal rights, the shareholder cannot vote in favor of the sale. Because this puts a snag in sales, term sheets usually note that these are lost in a drag-along situation.
Why do drag-alongs have a minimum purchase price?
To avoid common stockholders receiving nothing for the transaction, many drag-along will put a minimum purchase price, or liquidation price, in the contract. This helps avoid unfavorable or unprofitable terms, as many venture capitalist firms will lose money if the liquidation price is met.
Can minority shareholders freeze out mergers?
Minority shareholders can also hold up transactions approved by the super-majority, causing a freeze-out of a merger. Although drag along rights protects majority shareholders, they also aid minority shareholders. Because the sale price, terms, and conditions are the same as the majority, minority shareholders can get a cut ...
Why are tag-along rights important?
Tag-along rights are mainly used to ensure that the stake of minority stakeholders is considered during a company sale. Tag-along rights also provide greater liquidity to minority shareholders. The minority investors are entitled to the same price and conditions as the majority investor when the shares are sold.
What are the advantages of tag-along rights?
One of the most basic advantages of using tag-along rights is that it gives the business' minority shareholders (including, sometimes, employees given stock ownership) financial and legal protection when the company is being sold.
Why do minority shareholders have tag-along rights?
Tag-along rights benefit minority shareholders because they're able to receive the same benefits the majority shareholders bargain for . The flip side of this coin is that tag-along rights may discourage majority shareholders from investing in the company.
What happens when a majority shareholder sells his stake?
If a majority shareholder sells his stake, it gives the minority shareholder the right to join the transaction and sell their minority stake in the company. Tag-alongs effectively oblige the majority shareholder to include the holdings of the minority holder in the negotiations so that the tag-along right is exercised.
What is a come-along clause?
A come-along clause, also referred to as drag-along rights, force minority shareholders to sell their shares when majority shareholders decide to sell theirs. A come-along clause is essentially the opposite of tag-along rights.
Can tag-along rights be used for a sale?
Tag-along rights can sometimes make it more difficult for a sale to be completed.
What is a tag along rights?
Tag along rights are there to protect small investors, or minority shareholders. It gives them the right to get the same deal as the majority investor. Drag along rights, on the other hand, protect the majority stakeholder's interest by preventing liquidation of the stock and allowing them to force minority share holders to sell their stock at ...
Why is tag along rights important?
Using tag along rights is a good way to offer legal and financial protection for employees and smaller investors.
What happens if a shareholder's document includes tag along rights clauses?
If a buyer knows that the shareholder's document includes tag along rights clauses, they might be forced to offer to buy more shares than they want to hold in the company. If you need help with tag along rights, you can post your question or concern on UpCounsel's marketplace.
What happens if a principal stakeholder of a company liquidates its share?
If a principal stakeholder of the company liquidates its share, smaller investors won't get a bad deal. In simple words: If Investor A is selling their interest in the company, Investor B gets to sell their interest on the same terms and conditions.
What happens if a company does not offer to buy the remaining 25% of the shares?
If the person or company buying the majority shares does not offer to buy the remaining 25 percent of the shares, that breaks the tag along rights agreement.
What happens to Investor B when a new entity owns the majority of the shares?
Investor B will also have to deal with changes when a new entity owns the majority of the shares. With tag along rights, Investor B can sell his or her shares at the same price as Investor A and get the same return on the investment.
When is it necessary to determine cross class tag-along rights?
When the limited liability company has a complicated ownership structure, it is necessary to determine crossclass tag-along rights as well. This will increase the dependency of shareholders and cut the risk of one sale disadvantage to the rest of the investors.
Triggering Drag Along Rights
- Before majority owners can force minority owners to participate in the sale of the company, they should consider the following issues:
Allocation of Sales Proceeds
- The distribution of sales proceeds of the company is a contentious issue between majority owners and minority owners. Majority owners typically want as much flexibility as possible in negotiating the terms of the sale. They may want to receive payments in the form of cash or other considerations such as securities in the acquiring company. On the other hand, minority owners …
Remedies If Minority Owners Fail to Comply
- Due to the nature of drag sale rights, minority owners may be uncooperative or refuse to comply with the sale procedures. Majority owners may seek to include certain provisions in the drag along right to avert any resistance by the minority owners to the sale. The first remedy that majority owners can take is to request minority owners to grant an ...
Related Readings
- Thank you for reading CFI’s guide to drag along rights. To learn more, see the following CFI resources: 1. Sale and Purchase Agreement 2. Capital Structure 3. Divestiture 4. Corporate Structure
What Are Tag-Along Rights?
Understanding Tag-Along Rights
Advantages and Disadvantages of Tag-Along Rights
Example of Tag-Along Rights
Tag-Along Rights FAQs
- What Is the Difference Between Tag-Along Rights and Drag-Along Rights?
Tag-along or co-sale rights are essentially the opposite of drag-along rights. Whereas tag-along rights give minority shareholders negotiating rights in the event of a sale, drag-along rights force the minority shareholders to accept whatever deal is negotiated by majority shareholders. - Do Tag-Along Rights Make it Easier or Harder to Sell Shares in a Company?
In some instances, tag-along rights can make the selling process more difficult. It becomes harder to complete the sale when the potential buyer doesn't want to increase or change the terms of their offer in order to please minority shareholders.