Tag-along and drag-along rights are important clauses commonly found in shareholders’ agreements and / or the articles of association of a company and are used to protect the interests of the shareholders of a company. Tag-along rights primarily benefit minority shareholders and drag-along rights are favourable to majority shareholders.
What are tag-along rights?
If a majority shareholder decides to sell their shares and receives an offer to do so, tag-along rights enable a minority shareholder to join the transaction and sell their shares for the same price and on the same terms as the majority shareholder has agreed. Tag-along rights therefore oblige the majority shareholder to include minority holders in the negotiations so that the tag-along right is exercised. Tag-along rights also, therefore, allow minority shareholders to obtain favourable terms that would probably be otherwise unattainable. Generally, without tag-along rights, minority shareholders have very limited rights as they do not have a controlling interest in the company.
Despite the clear advantages of tag-along rights to minority shareholders, there are some drawbacks, for example, tag-along rights could be seen to discourage majority shareholders from investing as they will have an obligation to make decisions to not only benefit themselves but the minority shareholders too and this may enforce unfavourable obligations upon them.
What are drag-along rights?
A drag-along right enables a majority shareholder to force a minority shareholder to join in the sale of a company. Drag-along rights are different to tag-along rights as although tag-along rights do not oblige the minority shareholders to sell, drag-along rights do. This means that minority shareholders have no choice in the decision to sell and are therefore forced to do so if drag-along rights are triggered. However, the minority shareholder usually receive the same price as the majority shareholders and otherwise sell on the same terms.
Although drag-along rights may be seen to hamper the rights of minority shareholders as it forces them to sell, it provides an advantage to majority sellers as it gives them the right to acquire 100% of the share capital of the company and therefore, they are protected against being with a minority shareholder group who could prove to be uncooperative.
What factors should you consider when negotiating tag-along and drag-along rights?
There are a few common factors which you should consider when negotiating tag-along and drag-along provisions, these include:
- Threshold trigger: what constitutes a majority for the purpose of determining when drag-along rights may be exercised.
- When do tag-along rights apply: are they triggered if the majority shareholder decides to sell part of its shareholding, but not all or if it should only be triggered when the majority shareholder is selling its whole shareholding.
- Representations & warranties: should minority shareholders be required to give the same representations and warranties as well as the majority shareholders.
- Price: minority shareholders may insist on a minimum price for their shares to avoid being forced to sell at a low price and this should be considered carefully, a fair and independent valuation should be sought which ensures fairness and feasibility of a drag-along mechanism, often a pre-agreed formula or a minimum price per share will be used.
- Form of consideration: on a sale of shares the consideration may not only be in cash, for example, shares may be allotted in the buyer. On the basis that the form consideration will take on a sale will be unknown when drafting drag-along and tag-along rights, all forms of consideration should be catered for to give Majority Shareholders the ability to still exercise the drag-along rights whatever form the consideration takes.
- Notice periods: the amount of time shareholders have to exercise their drag-along rights or to respond to a drag-along notice should be agreed to ensure that the timeframes given are achievable.
How Moore Barlow can help
Tag-along and drag-along rights are highly variable and so time should be taken to properly negotiate these clauses to fully understand how they work, the consequences of them and ensure that they are fair and attainable for a company’s shareholders. Our corporate solicitors have a wealth of experience in corporate matters and regularly advise on tag-along and drag-along rights in shareholders’ agreements and articles of association. For more information about how our solicitors can help you, contact the Moore Barlow corporate team today.
