Drag along: Overview, definition, and example
What is a drag along?
A drag-along right is a provision commonly found in shareholder agreements or investment contracts. It allows a majority shareholder (or group of shareholders) to force minority shareholders to sell their shares in the event of a sale or acquisition of the company. This provision ensures that the entire company can be sold to a third party without the minority shareholders blocking the deal. Essentially, it "drags" the minority shareholders along with the majority's decision to sell the company.
In simpler terms, a drag-along right allows the majority shareholders to compel the minority shareholders to sell their shares if the company is being sold.
Why is a drag along important?
A drag-along provision is important because it provides a smooth process for selling the company. Without a drag-along clause, minority shareholders could block a sale or make the process complicated by refusing to sell their shares. This could make it harder to negotiate a sale, especially when a buyer is only interested in acquiring the entire company. The drag-along right ensures that majority shareholders have the power to finalize the sale without resistance from smaller stakeholders, making the process more efficient and straightforward.
For SMB owners, having a drag-along clause can be beneficial when looking for potential buyers, as it ensures all shareholders are aligned and committed to selling the business when the time comes.
Understanding drag along through an example
Let’s say your business has two major investors: Investor A, who owns 70% of the shares, and Investor B, who owns 30%. If you receive an offer from a third party to purchase the company, Investor A can invoke the drag-along clause and force Investor B to sell their 30% share in the company, even if Investor B doesn’t want to sell. This allows the sale to go through without any delay or complication from the minority shareholder.
In this case, the drag-along clause ensures that the majority shareholder can move forward with a sale without opposition from the minority shareholder.
Example of a drag along clause in an agreement
Here’s an example of what a "drag along" clause might look like in a shareholder agreement:
“In the event that the Majority Shareholder(s) agree to sell the company or substantially all of its assets to a third party, the Majority Shareholder(s) shall have the right to require all other shareholders to sell their shares on the same terms and conditions as the Majority Shareholder(s). The Minority Shareholders shall be obligated to participate in the sale and transfer their shares to the third party buyer.”
Conclusion
A drag-along provision is a powerful tool for ensuring that a business sale can proceed smoothly and efficiently, even if there are minority shareholders who might not agree to the sale. For SMB owners, including a drag-along right in shareholder agreements can help protect the ability to sell the company and make the process easier, especially if a sale opportunity arises. It ensures that all shareholders are aligned with the decision and helps avoid complications during a sale.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.