Drag along and tag along rights in Shareholders’ Agreements
Drag along and tag along rights are important forms of investment realisation in shareholders’ agreements. Tag along rights protect minority shareholders in the event that a majority shareholder (or a group of shareholders representing a majority) exits the company. Drag along rights, on the other hand, favour majority shareholders (or group of shareholders representing a majority) who want to compel minority shareholders to join a sale.
These provisions play a crucial role in protecting the rights and interests of shareholders where a majority or entire shareholding of the company is being sold.
What is a tag along right?
Tag along rights give minority shareholders the right to have their shares bought for the same price and on the same terms as a majority shareholder. They protect minority shareholders in the event that a majority shareholder exits the company, leaving minority shareholders ‘stranded’. They operate such that if the majority shareholder sells its shares to a third party, tag along rights oblige the majority shareholder to procure that the third-party purchaser extends its offer to include minority shareholdings.
What is a drag along right?
In the event of a sale of a controlling interest in the company, drag along rights give majority shareholders the right to force other minority shareholders to sell their shares to a third-party buyer. Drag along rights benefit majority shareholders by:
increasing marketability for prospective buyers by delivering the company with no minority interests; and
securing a high “premium for control” share valuation by delivering the entire interest the company.
How do you determine what a majority shareholder (or group of shareholders) is?
Generally, the shareholders’ agreement will specify a percentage for both the drag along and tag along which defines for the purposes of the drag along and tag along the majority shareholding percentage.
Often these percentages are fixed and the same (ie both are set at 75%). But it is common for the percentages to be set in order for certain groups of shareholders to be able to control certain outcomes, particularly following external funding.
Benefits and negatives of Drag Along and Tag Long Rights
Improved liquidity
The provisions make it easier for shareholders to sell their shares, thereby improving the liquidity of the company. This makes the company more attractive to prospective third-party buyers.
Protects minority shareholders
Tag along rights protect the interests of minority shareholders by providing them with a potentially viable exit route in circumstances where a majority shareholder liquidates its investment. This prevents minority shareholders from being locked into their investment with a new and unfamiliar partner.
Prevents conflict
By giving the majority shareholder the right to force the sale of minority shareholders, drag along rights help to prevent conflicts between shareholders in the event of a business sale.
Facilitates exits
The provisions make it easier to facilitate sale of the company by ensuring that all shareholders are able to sell their shares on the same or similar terms.
Manages risk and avoids uncertainty
Drag along and tag along rights manage risk and avoid uncertainty for parties by clearly stipulating the rights and obligations of each shareholder in the event of a sale.
A buyer may not want to buy 100% of the company
The tag along does not create an obligation upon the third party purchaser to buy the minority shareholders’ shares. Rather, it creates the obligation for the majority to procure the purchase of the minority’s shares. In this respect, if the buyer does not have sufficient capital or is not interested in buying the whole company, the deal for the majority shareholders could be negatively affected by the inclusion of a tag along.
How can we help you?
Importantly, tag along and drag along rights are negotiable, which means that the parties involved can negotiate terms and conditions to suit their specific needs and circumstances. Careful consideration and drafting are required to ensure that such provisions are tailored to suit the company and its shareholders.
Merton Lawyers are experts in corporate governance and preparing bespoke shareholders agreements. To discuss how we can assist you, please contact our corporate team to arrange for an initial consultation.
