Drag-along rights: Overview, definition and example
What are drag-along rights?
Drag-along rights are provisions in a contract that allow majority shareholders to force minority shareholders to join in the sale of the company, under the same terms and conditions. These rights ensure that if a majority of shareholders agree to sell their shares, the minority shareholders are required to sell theirs as well. It’s often included in shareholder agreements to streamline the process of selling the company, ensuring that minority interests do not block the sale.
Why are drag-along rights important?
Drag-along rights are important because they help facilitate the sale or merger of a company by preventing a small group of minority shareholders from blocking a deal. For the majority shareholders, drag-along rights provide the ability to sell the company without being delayed by dissenting minority shareholders. It also ensures that minority shareholders get the same terms as the majority, protecting their interests during a sale.
Understanding drag-along rights through an example
Imagine a startup with three co-founders: two hold 60% of the shares, and one holds 40%. If the two majority shareholders decide to sell the company to a larger firm, they can use the drag-along rights to require the minority shareholder to sell their shares as well. The minority shareholder must accept the same terms and conditions as the majority shareholders.
Another example could be an investor group that holds a majority stake in a company. If they decide to sell the company, drag-along rights would compel the smaller shareholders to also sell their stakes, ensuring that the deal proceeds without holdouts.
Example of a drag-along rights clause
Here’s how a drag-along rights clause might look in a shareholder agreement:
“In the event that the majority shareholders agree to sell their shares in the Company, the minority shareholders agree to sell their shares on the same terms and conditions as the majority shareholders. The majority shareholders shall have the right to compel the minority shareholders to sell their shares in connection with such a transaction.”
Conclusion
Drag-along rights ensure that the sale of a company can proceed smoothly by preventing minority shareholders from blocking the deal. They protect the majority shareholders by allowing them to act decisively in a sale, while also ensuring minority shareholders are treated fairly with the same terms as the majority. For businesses looking to raise capital or position themselves for a sale, understanding drag-along rights is crucial for managing shareholder dynamics and preparing for strategic exits.
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.