What are Tag Along and Drag Along Provisions
Drag-along and tag-along clauses are important terms that are commonly found in shareholders agreements.
What is a shareholders agreement?
A shareholders agreement is an agreement between a company and its shareholders as well as between the shareholders themselves. The agreement sets out each party’s rights, obligations and liabilities. It covers issues such as who can be a shareholder; who can sit on the board of directors; what happens if a shareholder cannot carry out their duties; how much shares are worth and how shares can be bought and sold. They also provide a mechanism for dispute resolution.
Shareholders can be minority shareholders, who own a small proportion of the overall shares in the company, or majority shareholders, who own a significant proportion of the company’s shares. Majority shareholders have a lot more power than minority shareholders by virtue of the fact that they own a greater proportion of the company. One of the functions of the shareholders agreement is to balance the rights and powers of majority shareholders and minority shareholders. Tag-along and drag-along clauses are examples of terms that seek to balance minority and majority shareholder interests.
What is a tag-along clause?
Tag-along clauses operate to protect minority shareholders when majority shareholders sell their shares. The tag-along clause allows minority shareholders to force majority shareholders to get the same sale terms and price for the minority shareholders as a condition of selling the majority shares. This clause protects minority shareholders because it gives them more agency when their company is being sold and doesn’t force them to accept a takeover bid that could potentially result in devaluing their shares.
What is a drag-along clause?
A drag-along clause protects majority shareholders from minority shareholders who may use their stake to block a takeover bid. For example, a buyer may want to acquire a 75% stake in a company, in order to be able to pass what are called special resolutions. Alternatively, the buyer may want to acquire 100% of the company.
If the majority shareholders only own 50% or 60% of the company’s shares, the minority shareholders have the power to hold out for a better deal before agreeing to sell their shares to the buyer. A drag-along clause avoids this situation because it allows majority shareholders to force minority shareholders to sell their shares for the same sale terms and price as the majority shareholders.
If you would like some advice on tag-along or drag-along clauses or you would like assistance drafting a shareholders agreement for your start up, please get in touch.