Business Law
Thursday Terminology
Drag-along & Tag-along
When you own shares in a private company there may be situations where a majority wants to force a minority to sell their shares along with them, and other situations where the minority wants to get to sell their shares together with a majority that's about to sell. This is where the drag and tag becomes central. Let's have a look at their applicability and meaning.
Intro
When you hold shares in a private company there will typically be a shareholders agreement (an "SHA") regulating fundamental matters of governance, finance and the ability for the parties to sell their shares to any third party not already a shareholder and not already party to the SHA. The regulation regarding restrictions on the transferability of the shares typically adresses key matters that have proven to be central to regulate in advance in order to minimize the risk for conflict, miss-use of powers and in order to facilitate that an attractive exit can be made.
Drag-along
In what situations does the drag-along become relevant?
If you are looking to make an exit in the future – basically to sell the company (making it a good return on investment) – a potential buyer will in many cases only be interested in buying the whole company, and accordingly does not want any minority shareholders hanging on, remaining on the captable with both financial and control rights (to some extent), not least a right to take part in the general meetings. This fact, that an identified buyer of the company might not buy the company if it cannot acquire all outstanding shares, could give minority shareholders a golden opportunity to block offers and transactions with the attempt to either (i) get a sweeter deal or (ii) ensure that the transaction cannot be made despite the majority of the shareholders wanting the deal to go through.
How does the drag-along work?
Here is when the drag along comes in. It is customary for SHAs to include a so called drag-along clause that states that if a majority of e.g. 75 % (could be a higher, could be a lower precentage) wants to sell – they have the right to drag, that is to force, the remaining shareholders to accept the same deal. The drag may typically only be used to force a sale at the same terms – so the majority cannot push a deal through that is worse for the minority. This kind of clause will effectively ensure that an exit can take place without blockage.
Tag-along
In what situations does a tag-along become relevant?
How about the other way around? For instance, if you have an opportunity to sell your (majority) stake to a strategic owner that would not mind having minority shareholders left on the cap table (and accordingly pay less while still gaining control) as it will run and keep the company in a way that won't be hindered by such a minority shareholder? In such cases, a tag-along right can be crucial for the minority shareholders.
How does the tag-along work?
This is when the tag-along right comes in. It is the flipside of a drag along, and serves as a minority protection. In case a majority wants to sell, with a tag-along the minority has a right to demand that they to get to sell at the same price and other terms as the majority shareholder. This means an obligation for the majority shareholders to ensure that this happens, and in case the majority shareholders and the tagging minority cannot all sell all of their offered shares on these conditions (e.g. because the offer is only for 75 % of the shares) then the default position is that all participants will be scaled back on a pro rata basis so that both the minority and the majority get to sell 75 % of their shares (and remain with 25 % of whatever sharecount they had before the sale). This ensures that the majority cannot make an exit leaving the minority without any realistic prospects of a future exit.
Important variations of the drag and tag
Note that both drag and tag along right are contractual mechanisms which means that the design of the clauses, and the details therein, will vary. For example - should a drag-along be applicable only in situations of an offer to acquire 100% of the company, or also in relation to partial offers to buy shares? So be very careful as to ensure that you fully understand the SHA and the drag-along and tag-along provisions applicable to the shares you buy or hold.
Intro
When you hold shares in a private company there will typically be a shareholders agreement (an "SHA") regulating fundamental matters of governance, finance and the ability for the parties to sell their shares to any third party not already a shareholder and not already party to the SHA. The regulation regarding restrictions on the transferability of the shares typically adresses key matters that have proven to be central to regulate in advance in order to minimize the risk for conflict, miss-use of powers and in order to facilitate that an attractive exit can be made.
Drag-along
In what situations does the drag-along become relevant?
If you are looking to make an exit in the future – basically to sell the company (making it a good return on investment) – a potential buyer will in many cases only be interested in buying the whole company, and accordingly does not want any minority shareholders hanging on, remaining on the captable with both financial and control rights (to some extent), not least a right to take part in the general meetings. This fact, that an identified buyer of the company might not buy the company if it cannot acquire all outstanding shares, could give minority shareholders a golden opportunity to block offers and transactions with the attempt to either (i) get a sweeter deal or (ii) ensure that the transaction cannot be made despite the majority of the shareholders wanting the deal to go through.
How does the drag-along work?
Here is when the drag along comes in. It is customary for SHAs to include a so called drag-along clause that states that if a majority of e.g. 75 % (could be a higher, could be a lower precentage) wants to sell – they have the right to drag, that is to force, the remaining shareholders to accept the same deal. The drag may typically only be used to force a sale at the same terms – so the majority cannot push a deal through that is worse for the minority. This kind of clause will effectively ensure that an exit can take place without blockage.
Tag-along
In what situations does a tag-along become relevant?
How about the other way around? For instance, if you have an opportunity to sell your (majority) stake to a strategic owner that would not mind having minority shareholders left on the cap table (and accordingly pay less while still gaining control) as it will run and keep the company in a way that won't be hindered by such a minority shareholder? In such cases, a tag-along right can be crucial for the minority shareholders.
How does the tag-along work?
This is when the tag-along right comes in. It is the flipside of a drag along, and serves as a minority protection. In case a majority wants to sell, with a tag-along the minority has a right to demand that they to get to sell at the same price and other terms as the majority shareholder. This means an obligation for the majority shareholders to ensure that this happens, and in case the majority shareholders and the tagging minority cannot all sell all of their offered shares on these conditions (e.g. because the offer is only for 75 % of the shares) then the default position is that all participants will be scaled back on a pro rata basis so that both the minority and the majority get to sell 75 % of their shares (and remain with 25 % of whatever sharecount they had before the sale). This ensures that the majority cannot make an exit leaving the minority without any realistic prospects of a future exit.
Important variations of the drag and tag
Note that both drag and tag along right are contractual mechanisms which means that the design of the clauses, and the details therein, will vary. For example - should a drag-along be applicable only in situations of an offer to acquire 100% of the company, or also in relation to partial offers to buy shares? So be very careful as to ensure that you fully understand the SHA and the drag-along and tag-along provisions applicable to the shares you buy or hold.