Understanding the Significance of Tag-Along and Drag-Along Rights in Business Ownership
In the realm of business ownership, certain rights play a crucial role in protecting the interests of both majority and minority shareholders. Two such rights are Tag-Along and Drag-Along rights. While they may sound similar, they serve distinct purposes and significantly impact shareholder transactions.
Tag-along rights, also known as “co-sale rights,” bestow minority shareholders with a level of protection and participation in the event of a majority shareholder’s decision to sell their shares. By exercising tag-along rights, minority shareholders can join the majority shareholder’s sale and sell their shares at the same price and on the same terms.
Conversely, when a majority shareholder receives a compelling offer to sell the entire company, drag-along rights allow them to force minority shareholders to sell their shares alongside them. This provision ensures that a prospective buyer can acquire the entirety of the business without facing hindrances from minority shareholders.
Both of these rights hold significance and warrant thorough consideration during each transaction.
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Today, we’re jumping into a very specific concept called drag-along and tag-along rights. You’ll find them in a shareholder’s agreement or an operating agreement or a limited partnership agreement. In either case, they’re all agreements among the owners.
What these provisions mean or relate to is when you sell your shares of your company. In particular, we’ll start with drag along. A drag-along rate would mean that a party selling their shares to a third party can force the other shareholders to have to sell their shares too. The result is that all of the shares of the company are being sold.
Now, that’s good in many cases for a buyer, because a buyer is going to want to have certain control, but the whole is better than the parts in this context. So it’s desirable for a buyer. It might destroy the deal, actually, if the buyer is only able to buy a small percentage of noncontrolling shares.
The other option is a tag-along. Tag along, I think we use less often than drag along. Drag along is better in most cases than tag along. Tag along basically says, “Okay, well, if you’re selling your shares, you have to include our shares in the sale.”
And so what that does is you have a situation where maybe the controlling shareholder is selling their shares to a buyer, and now the buyer is being told that, “Well, to buy these shares, you have to buy all of them.” And that’s going to probably destroy the deal if the buyer is not interested in that, because that means the buyer is going to probably have a lot more money. And that may not be desirable for the buyer.
So the buyer may not want the tag-along rights, whereas the drag-along rights might be much more desirable to a buyer, because they might want the whole thing. And that’s the way to force that issue. So drag along, tag along. You should see them in most agreements or at least one of them. And that’s what they are.
I hope you found this helpful. And thanks for tuning in and stay tuned for more.
Points to Remember about Tag Along and Drag Along Rights
- Purpose: Tag-along rights protect minority shareholders by allowing them to join a sale of shares initiated by majority shareholders. Drag-along rights empower majority shareholders to force minority shareholders to sell their shares in a transaction involving the entire company.
- Participation: Tag-along rights enable minority shareholders to participate in a sale on the same terms and conditions as the majority shareholders. Drag-along rights compel minority shareholders to sell their shares alongside majority shareholders.
- Impact on Valuation: Drag-along and tag-along rights can impact the valuation of minority shareholding. Tag-along rights allow minority shareholders to realize the value of their shares. However, drag-along rights may result in minority shareholders being forced to sell at a time and price they may not desire.
How Tag Along and Drag Along Rights Empower Shareholders
These rights provide important safeguards and opportunities for both minority and majority shareholders.
The valuation of minority shareholding can be significantly influenced by these rights, making it essential for shareholders to consider their implications carefully. By navigating negotiations fairly and transparently, shareholders can strike a balance that benefits all parties involved. Ultimately, effectively leveraging drag-along and tag-along rights can lead to empowered decision-making and thriving business ecosystems.
These rights are integral to shareholder agreements, providing crucial protections and opportunities for minority and majority shareholders alike.
Understanding the nuances of these rights, their implications, and their impact on valuation is essential for business owners navigating the intricate landscape of shareholder transactions.
Want to learn more about how this impacts you specifically? Contact Haimo Law today.