What are drag-along rights?
Drag-along-rights allow majority shareholders to force minority shareholders to sell their stakes in a company. These rights are a provision, usually stipulated as part of a share issue or equity for capital deal. They allow the majority shareholders to control the direction of the company.
Because drag-along-rights are used to force through a sale, they can create conflict both within the boardroom and within the ownership of the company. With this in mind, let’s look at simplifying how drag-along-rights work and how they affect startup founders.
Drag-Along-Rights and their Terms
These contractual provisions get their name from majority shareholders “dragging” minority shareholders, against their will, towards selling their shares. At first glance, this seems quite unfair. After all, a minority shareholder may want to hold onto their share of a business.
However, there are counter stipulations that make being dragged into a sale a little easier to swallow. These stipulations are included to ensure that minority shareholders are treated as fairly as possible, even when being forced into selling.
Minority drag-along-rights protections include:
- Majority owners only being able to force minority shareholders into a sale by offering them the same price and conditions offered to all other sellers. This stops minority shareholders from being short-changed with a lower offer.
- Minority shareholders may be able to secure more favorable sales terms than they would otherwise have been able to, though this is not guaranteed.
Drag-Along-Rights: The Majority Shareholder Perspective
It’s clear to see that when any drag-along-rights provisions are activated, the experiences of the majority and minority shareholders will differ drastically from each other. Despite the protections put in place for minority shareholders to at least soften the blow of a forced sale, drag-along-rights are designed to benefit majority shareholders the most.
If all shareholders were given an equal say on whether a business is sold, then all it would take is for one minority shareholder to block the sale. Needless to say, for those who have invested much larger amounts, this obstruction would be extremely uncomfortable, especially if it blocked any meaningful exit strategy.
The beauty of drag-along-rights provisions then, is that they protect the majority shareholder’s interests. They effectively ensure that the majority shareholder decides when a business is sold and at what value.
If the majority shareholder likes an offer being made for the company, they do not need the permission of minority shareholders in this situation to accept the offer. This also means that a majority shareholder can actively pursue buyers to make an offer, effectively controlling when they can make an exit.
Drag-Along-Rights: The Minority Shareholder Perspective
If drag-along-rights are there to benefit the majority shareholder, then it’s clear that they put the minority shareholder at a disadvantage. For the minority shareholder, this is a stipulation that takes control out of their hands.
However, a minority shareholder should be aware of “tag-along rights” which allow some minority shareholders to benefit from a forced sale.
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