Tag-along and drag-along

What it means

Tag-along and drag-along are two contractual clauses governing what happens to the other shareholders’ stakes when someone sells theirs. They are usually part of a shareholders’ agreement or investment agreement and are negotiated as early as the term sheet.

Tag-along, the right to join a sale, protects minority shareholders. If the majority shareholder sells to a buyer, the minority may sell their stakes to the same buyer on the same terms. They are therefore not left in the company with a new owner they did not choose.

Drag-along, the obligation to join a sale, protects the majority and the buyer. If a majority of shareholders agree to sell the whole company, they can require the minority to sell on the same terms. A buyer who wants one hundred per cent cannot then be blocked by a single small shareholder.

How it works in practice

When drafting shareholders’ agreements with clients we set the threshold at which the clauses are triggered, whether they apply only to a sale of a whole stake or also part of it, and the minimum price under drag-along. With venture capital investors a minimum return is often agreed too.

The clauses are combined with a pre-emption right. The usual order is that a shareholder must first offer the stake to the others, and only if they do not buy do the tag-along and drag-along rules apply to a sale to a third party.

In a limited company, a share transfer must also comply with the articles of association. If the shareholders’ agreement promises something the articles prevent, the clause is hard to enforce. We therefore prepare both documents together.

What to watch out for

A drag-along without minority protection can lead to a forced sale at a low price. Minority shareholders should insist that it applies only on a sale of the whole company to an independent buyer at the same price per share as the majority receives.

Clauses in a shareholders’ agreement bind only its parties. A new shareholder who does not accede to the agreement is not bound. With every share transfer we therefore recommend that the acquirer accede to the agreement in writing.