What are drag-along rights?
Drag-along rights (sometimes referred to as a 'come along' right or 'bring along' right) principally enable a majority shareholder to force the minority shareholder to also sell their shares in the company (though if a VC fund holds a minority stake in a company, it will expect to have the benefit of a drag-along right). This guarantees that the majority can deliver 100% of the share capital of a company to a bona fide third-party purchaser.
Key negotiation points for drag-along rights
When drafting and negotiating drag-along provisions, you may wish to consider the following:
- Threshold: Parties need to determine the threshold (i.e. the percentage of shares) that will trigger the drag-along right. This threshold is usually around 75% but this can be lower depending on the structure and bargaining power of the parties.
- Pre-emption rights: Pre-emption rights will usually take precedence where an agreement is silent on the interrelationship between a drag-along right and a pre-emption right. It is therefore important to ensure that this is addressed to allow the majority shareholder the ability to negotiate with the purchaser without being subject to the limitations of pre-emption rights.
- Consideration: Usually drag-along rights are drafted on the basis that the purchaser provides cash consideration. It is vital that the drag-along provision clearly sets out whether non-cash consideration is permitted as per the Cunningham v Resourceful Land Limited case.
What are tag-along rights?
Tag-along rights (sometimes referred to as a 'co-sale' right or 'piggyback' right) are provisions typically used to protect minority shareholders. In the event that the majority shareholder decides to sell its shares, tag-along rights allow the minority shareholders to participate in the sale at the same time and for the same price. These rights prevent the minority shareholders from being locked in without a viable exit.
A tag-along right provides better protection for the minority than any pre-emption rights (the right of first refusal in favour of existing shareholders to participate in a fresh allotment or on a transfer) as it does not rely on the minority having the funds to purchase the shareholding of the majority.
In practice, it is rare to see a tag-along right exercised as the majority shareholders will secure the best price by procuring the sale of the entire issued share capital.
Key negotiation points for tag-along rights
There are a range of factors to consider when drafting and negotiating tag-along rights, such as:
- Sale of all or part shares: Consideration should be given as to whether the tag-along rights should apply to the sale of some or all of the majority shareholder's shares. A minority shareholder will want to negotiate the tag so that it applies to an agreed percentage of the majority shareholder's shares to prevent a situation where the majority can sell a significant stake (but not all) without triggering the tag-along provision.
- Notice and timing: It is important to establish procedures for providing notice to minority shareholders regarding the proposed sale and the exercise of tag-along rights. A timeline for responding to the offer and exercising tag-along rights should be clearly defined to ensure minority shareholders have sufficient time to make informed decisions.
- Execution and enforcement: Determine the mechanisms for executing tag-along rights and enforcing compliance with the negotiated terms. This may include provisions for transferring shares, co-ordinating with the majority shareholders and resolving any disputes that arise during the process.
DWF has a market-leading venture and growth capital practice in the UK, supporting investors and companies across several sectors including financial services, technology, media and telecommunications, life sciences and healthcare and real estate and infrastructure.
If you have queries on any of the issues covered in this article please contact one of our experts.
The experts include:
- Dhruv Chhatralia BEM
- Caroline Colliston (as the tax representative for the corporate articles)
- Darren Ormsby
- Gary MacDonald
- Paul Pignatelli
- Scott Kennedy
- Will Munday
- Alex Stoughton
- Graham Tait
- Rosie Spencer
