Definition of a Drag Along Right
A drag-along right is a contractual arrangement that allows for the sale of a minority shareholder’s stake in a business to be “dragged along” with the sale of a majority stake. Accordingly, the majority shareholder can force a minority shareholder to join the sale of the company whether they want or not.
A drag-along right is typically included in a shareholder’s agreement, and it enables a majority shareholder to ensure that the sale of their portion of the company is successful. This gives minority shareholders the chance to benefit from the sale of the company, even if they don’t want to be part of the deal.
Understanding Drag-Along Rights
Drag-along rights are a type of corporate governance right that gives investors the ability to force a sale of the company, even if a minority of owners disagree. These rights are often included in a corporate charter or other agreements between investors and allow a majority shareholder to sell their stake in the company to a third party.
They are designed to protect the rights of investors who may be unable to negotiate a sale of their interest in the company on their own. Drag-along rights ensure that all stakeholders in a company receive fair value for their holdings in the event of a sale.
Benefits of Drag-Along Rights for Minority Shareholders
Here are the key benefits of drag-along rights for minority shareholders:
- First, this type of provision requires that the price, terms, and conditions of a share sale be the same across the board, which means that small equity holders can benefit from favorable sales terms that would otherwise be unattainable.
- Second, drag-along rights protect minority shareholders from potential “lowball” offers from majority shareholders by allowing them to negotiate a fair price for their shares.
- Finally, drag-along rights can provide minority shareholders with greater liquidity.
Drag-Along Rights vs. Tag-Along Rights
Understanding the difference between drag-along rights and tag-along rights is essential in approaching any business deal such as M&A. Drag-along rights allow the majority shareholders of a company to force minority shareholders to join in the sale of the company to a third party. Tag-along rights, on the other hand, allow minority shareholders to tag along with the majority shareholders in the sale of the company to a third party but don’t mandate an obligation. Both rights are important to understand when negotiating a business deal, as they can have a significant impact on how much money the shareholders make from the sale.
The Bottom Line
In conclusion, drag-along rights are an important consideration when entering negotiations with investors. While they are beneficial to the investor and can help to ensure a smooth transition of control, they can also be detrimental to the founders. Keeping these rights in mind and understanding the implications of granting them is essential for founders to make an informed decision. With careful consideration and negotiation, drag-along rights can be implemented in a way that is beneficial to both the investor and the founder.