Dear Friends,

As you are aware that ,when you are going for investment or acquisition of a company, you enters into a Shareholders /Share-Purchase Agreement. This Agreement is between the Investor , Company and the Shareholders of the company. A Shareholders’ agreement is an important contract between shareholders and the company, and between the shareholders themselves. It governs the shareholders’ rights, obligations and liabilities. Provisions commonly found in a shareholders agreement can include a compulsory transfer of shares, pre-emption rights and drag along and tag along rights.

INVESTOPEDIA DEFINES ;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.

Share offerings, mergers, acquisitions, and takeovers can be complicated transactions. Certain rights may be included and instituted with the terms of a share class offering or in a merger or acquisition agreement.

Drag-along rights may be included and instituted with the terms of a share class offering or in a merger or acquisition agreement.

Drag-along rights eliminate the current minority shareholders through the sale of 100% of a company’s securities to a potential buyer.

Tag-along rights differ from drag-along rights since tag-along rights offer the minority shareholders the option to sell but do not mandate an obligation.

The drag-along provision itself is important to the sale of many companies because buyers are often looking for complete control of a company. Drag-along rights help to eliminate the current minority owners and sell 100% of a company’s securities to a potential buyer.

While drag-along rights themselves may be clearly detailed in an agreement, differentiation between majority and minority may be something to watch out for. Companies can have different types of share classes.

A company’s bylaws will denote the ownership and voting rights that shareholders have, which may have implications on majority vs. minority.

WHAT ARE DRAG ALONG RIGHTS?

A drag along right allows a majority shareholder (i.e. 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 (i.e. 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’. 

PLEASE NOTE THAT: 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.

While drag-along rights are meant to mitigate minority shareholder effects, they can be beneficial for minority shareholders. This type of provision requires that the price, terms, and conditions of a share sale be homogeneous across the board, meaning small equity holders can realize favorable sales terms that may be otherwise unattainable.

Typically, drag-along right provisions mandate an orderly chain of communication to the minority shareholders. This provides advance notice of the corporate action mandated for the minority shareholder. It also provides communication on the price, terms, and conditions that will apply to the shares held by the minority shareholders. Drag-along rights can be nullified if the proper procedures surrounding their enaction are not followed.

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.

INVESTOPEDIA DEFINES; Tag-along rights also referred to as “co-sale rights,” are contractual obligations used to protect a minority shareholder, usually in a venture capital deal. 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.

KEY TAKEAWAYS

• Tag-along rights are contractual obligations to protect a minority investor in a startup or company.
• 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.
• Tag-along rights can sometimes make it more difficult for a sale to be completed.

Tag-along rights are pre-negotiated rights that a minority shareholder includes in their initial issuance of a company’s stock. These rights allow a minority shareholder to sell their share if a majority shareholder is negotiating a sale for their stake. Tag-along rights are prevalent in startup companies and other private firms with considerable upside potential.

Tag-along rights give minority shareholders the ability to capitalize on a deal that a larger shareholder — often a financial institution with considerable pull — puts together. Large shareholders, such as venture capital firms, often have a greater ability to source buyers and negotiate payment terms.

Tag-along rights, therefore, provide minority shareholders with greater liquidity. Private equity shares are incredibly hard to sell, but majority shareholders can often facilitate purchases and sales on the secondary market.

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.

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. When a sale is proposed, minority shareholders typically don’t possess enough bargaining power and legal knowledge to properly negotiate for a better deal. Tag-along rights benefit minority shareholders because they’re able to receive the same benefits the majority shareholders bargain for.

CONCLUSION: Drag-Along & Tag-Along rights are important parts of a Shareholders Agreement/Share-Purchase Agreement. In Drag-Along Right majority shareholder if wants to sale /negotiate  to sale their holdings they will drag the minority or enforce minority shareholders to shed their holding also in the same proportion ,so that sharing holding patters remain the same and minority shareholders do not oppose or restrict their exit from the concern.

On the other hand, in Tag-along rights , minority shareholders get right to participate in the sale/negotiation /deal through which majority shareholder going through or get same bargaining power same as majority shareholders. Through this right the majority shareholders are forced to offer same price, benefits to minority shareholders also if they want to exist from the entity.

DISCLAIMER: the article presented here is only for sharing information with readers. The views are personal, shall not be considered as professional advice. In case of need do consult with professional.

AUTHOUR: FCS Deepak P. SIngh [B.Sc. FCS, LLB, AIII, CIAFP]/cs.deepakpsingh@gmail.com

SOURCES:

1. https://www.investopedia.com/terms/t/tagalongrights.asp
2. https://www.investopedia.com/terms/d/dragalongrights.asp
3. https://www.rocketlawyer.com/gb/en/business/run-a-private-limited-company/legal-guide/drag-along-and-tag-along-rights#:~:text=Tag%20along%20rights%20are%20also,same%20price%20for%20the%20shares.