A Brief Introduction to Drag-Along Rights

In its simplest form, a drag-along right is a provision that  entitles the majority shareholder to force the minority shareholder to sell his shares upon the same terms and conditions at which the majority shareholder is selling his stake. This right prevents the minority shareholder from refusing to sell his shares in case a buyer wants to buy all the shares of the company.

When is this right exercised?

Drag-along rights are typically applied in cases of stock sales and mergers- where a buyer is looking to buy 100% of company’s shares (as opposed to company assets). This right facilitates the majority shareholder to take an exit by forcing (or “dragging along”) the minority shareholder to sell his shares.The logic behind this right is that the majority shareholder may have negotiated with his minority shareholder partner that the majority shareholder has the right to approve a sale of the company, regardless of the form or structure in which the sale is to take place. Without this right, the minority shareholder could refuse to sell his shares and further impede, if not prevent, the sale of the company in these certain transaction structures.

Who may trigger Drag Along?

Like other contractual agreements, the terms of a drag-along provision can be tailored and customized to the needs and wants of the parties. Drag-along rights are most frequently exercised by one or more of the following explicitly identified parties: shareholders holding a majority of the shares, shareholders holding some “supermajority” of shares, or shareholders holding some preferred class of shares.

Often, the drag-along provision provides that the transaction must yield some minimum gross proceeds to the company before it can be triggered (e.g., gross proceeds from the transaction must yield at least $X before it can be triggered and used by the dragging member).

The triggers of the drag-along should be carefully considered and drafted.

Conditions for triggering Drag Along Rights

The conditions for exercising the drag-along can be contractually tailored and customized. The terms and conditions of the sale of shares will vary depending on the company, but the effect should be that all of the shareholders will be treated equally and fairly. Typically, shares are all sold at the same price.  In addition, the drag-along provision may also include some protections for shareholders.  For example, a well crafted drag-along provision may protect shareholders from “claw backs” on distributions received in the event there are problems between the buyer and the company after closing.

How Drag Along is different from Tag Along

Tag Along is a right which protects certain identified shareholders (e.g., minority holders or holders of a particular class of stock) from being excluded from certain types of sales, like stock sales.  For example, a tag along right would protect a minority shareholder from the majority shareholder selling the controlling stake in the company (and achieving a liquidation event on its own stock) without giving the minority shareholder any liquidity it minority position.  The tag-along provision would state that the minority shareholder has a right to sell a portion of his shares of stock in the sale too (and reduce the number of shares the majority shareholder could sell).  So, the Tag-Along and Drag-Along protect different parties in different sets of circumstances.  

Understanding Drag Along and Tag Along rights can sometimes get very complex, and it is unwise to attempt to traverse these waters without the guidance of a knowledgeable attorney. Call the Doida Law Group today and let us guide you in all legal aspects of your corporate structure and shareholder rights.

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