Can I tag-along?

A brief explanation of tag-along and drag-along clauses

Tag-along and drag-along rights are now commonplace in investor, shareholder and stockholder agreements. This article explains who benefits from them, how they work and the common problems.

Tag-along Rights

A tag-along right benefits a minority shareholder.

It only comes into play if a majority shareholder wants to sell its shares, and a minority shareholder decides it would like to tag-along.

The contractual provisions that create the tag-along right oblige the majority shareholder to secure an offer from the proposed buyer to buy the shares of the minority shareholder at the same price and on the same terms offered to the majority shareholder.

In practice, there can be problems if the buyer is offering consideration other than cash. If an offer contains a cash and non-cash component, and the non-cash component is not suitable for the minority shareholder, the shareholders need to work out a way to value the non-cash component and ensure that all shareholders get a fair result.

Tag-along rights are sometimes known as co-sale rights.

Drag-along Rights

A drag-along right benefits a majority shareholder.

It usually comes into play where a majority shareholder finds a buyer for its shares, and the buyer makes the offer to buy conditional upon obtaining 100% ownership.

The contractual provisions that create the drag-along right oblige the minority shareholder to sell its shares to the buyer at the same price and on the same terms as negotiated with the majority shareholder. The minority shareholder is dragged-along, sometimes kicking and screaming.

A minority shareholder needs to ensure that it is protected against deals that are on uncommercial terms. For example, deals with related parties, or deals done in the absence of bona fide, arm’s length commercial negotiations. A minority shareholder might also be worried about non-cash consideration. While a majority shareholder might be happy to take securities in the buyer, the minority shareholder may not.

If you are investing in a company, or taking investor’s money you need to get the contractual provisions right. Negotiating them at the time of sale can leave you up against a wall.

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