These terms may be a mystery to the inexperienced. Tag along rights are a contractual obligation used to protect a minority shareholder (usually in a venture capital deal). If a majority shareholder sells his or her stake, then the minority shareholder has the right to join the transaction and sell his or her minority stake in the company.
Tag-along rights effectively oblige the majority shareholder to include the holdings of the minority holder in the negotiations in order to facilitate the possibility that a tag-along right is exercised.
Drag along rights on the other hand 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.
This is designed to protect the majority shareholder. Because some buyers are only looking to have complete control of a company, drag-along rights help to eliminate minority owners and sell 100% of a company’s securities to the buyer.
Such control over transfer of shares implies that, as a general rule, traditional shareholders rights on transfer of shares, such as rights of first refusal, need to be recognised to the management after deep consideration of the particularities of each transaction, as they may jeopardise an exit opportunity for the private equity (PE) investor.
Tag-along rights are appealing to PE companies when they hold a minority stake in a company and do not seek to become a majority shareholder. Such rights allow them to co-sell their stake, when the majority shareholder or the key directors/officers decide to sell theirs, without being obliged to stay in the company with a new third party or without the key individuals who manage (and/or control) the company. These rights are of a key importance in case that, for any reason, the PE company is not prepared to exercise its rights of first refusal.
When a shareholder seeks to sell its interest to a third party, tag-along rights enable a PE investor to co-sell its stake in the company under the same conditions as the selling shareholder.
So that these rights may be better enforceable in cases of dispute it is considered advisable to include them in a company’s constitution. To ensure the enforceability of these agreements in cases of disputes, it is advisable to always consider their inclusion in the Constitution of a company.
These rights should be considered when you propose to invest in a company. When in doubt, consult your legal advisor. Good luck
This article is for general information only and is not intended as legal advice. If you need specific help please contact our office.