Drag-along rights are contractual clauses, typically found in shareholder agreements, that empower majority shareholders to compel minority shareholders to participate in a company sale. These provisions play a significant role in aligning shareholder interests, especially when majority owners wish to proceed with a transaction.
How Drag-Along Rights Work
- For Majority Shareholders: Drag-along rights allow majority owners to sell the company according to their timeline and terms, compelling minority shareholders to join the sale even if they would prefer to retain their stake.
- For Minority Shareholders: Although drag-along rights may require minority shareholders to sell their shares, these rights generally ensure they receive the same price and terms as the majority. Minority shareholders may also negotiate “tag-along” rights to guarantee their inclusion in future sales on equal terms.
Drag-along provisions can be included in shareholder agreements, company bylaws or formation documents. Both majority and minority shareholders should carefully consider the terms of these clauses, as they could significantly impact any future sale.
The Value of Drag-Along Rights
Drag-along rights can make a company more appealing to potential buyers by ensuring that the buyer can acquire full ownership of the business, rather than only the majority interest. This prevents situations where a minority shareholder might block a sale or create complications that could derail the transaction entirely.
Who Benefits from Drag-Along Rights?
- Majority Shareholders: Drag-along rights simplify the sales process and reduce the risk of minority shareholder resistance, helping majority owners attract buyers and negotiate deals with greater control.
- Minority Shareholders: When properly structured, drag-along rights protect minority shareholders by ensuring they receive equal terms and compensation as the majority shareholder in any sale. Additionally, “tag-along” rights can provide minority shareholders with the option to join in on a sale if the majority owner is not using drag-along provisions.
What Triggers Drag-Along Rights?
Certain events or conditions, defined within the drag-along provision, will trigger the rights. Key considerations include:
- Types of Transactions: Determine which events will activate the drag-along provision, such as mergers, asset sales, or sales of ownership interests.
- Ownership Threshold: Specify the ownership percentage that must be sold to trigger the drag-along. For example, does a sale of 30% of shares trigger it, or does it require a larger portion?
- Advance Notice: Define whether majority owners must give advance notice of the sale to minority shareholders, including the timing and contents of such notices.
- Restrictions: Set any limitations, such as minimum sale prices or waiting periods, to ensure a fair process for all shareholders.
Sale Proceeds and Procedures in Drag-Along Sales
It’s essential to clarify how sale proceeds will be distributed. Majority shareholders may negotiate for illiquid securities if it benefits the deal, whereas minority shareholders might prefer cash proceeds. Other procedural questions may include:
- Transaction Costs: Decide which party will bear the costs of transaction expenses, including legal fees, valuation services and other expenses. These costs could be allocated based on ownership interest or charged solely to the shareholder invoking drag-along rights.
- Dispute Resolution: Outline a process for resolving disputes that may arise during a drag-along transaction.
A qualified attorney experienced in shareholder agreements can help anticipate potential scenarios, protect shareholder interests, and draft a balanced agreement.
Enforceability of Drag-Along Rights
Drag-along rights are enforceable when drafted in a clear, valid contract and adhered to precisely as outlined. For instance, if the provision mandates advance notice of a sale and minority shareholders don’t receive it until after the transaction, the provision might be deemed unenforceable in court.
Tag-Along Rights Explained
Tag-along rights offer protection to minority shareholders by giving them the right to join a sale if the majority shareholder decides to exit the company. This ensures they are not left behind with a new, potentially incompatible majority owner and can sell their shares on the same terms.
Drag-Along vs. Tag-Along Rights
While drag-along rights allow majority shareholders to compel a sale, tag-along rights enable minority shareholders to participate voluntarily in any sale negotiated by the majority. Essentially, drag-along rights enforce participation, while tag-along rights grant optional involvement. Understanding and negotiating drag-along and tag-along rights is essential for shareholders seeking to safeguard their interests in any future sales.
