What Are Drag-Along Rights? A drag-along right is a provision or clause in an agreement that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller.
What is drag along rights in law?
A drag-along right is a right that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price and terms and conditions as any other seller. ... Drag-along rights are designed to protect the majority shareholder.
What are drag-along rights in shareholder rights?
What Are Drag-Along Rights? A drag-along right is a provision or clause in an agreement that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller.
What does drag along mean in a contract?
A drag-along right is a provision or clause in an agreement that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller.
What are stock rights and how do they work?
Stock rights give their owner the right, but not the obligation, to buy the shares of a company at a specific exercise price for a designated period of time. The term primarily applies to giving current shareholders the right to buy additional shares as part of the issuer's next stock sale.
Who benefits from drag along rights?
Benefits of Drag-Along Rights for Minority Shareholders This provides advance notice of the corporate action mandated for the minority shareholder. It also provides communication on the price, terms, and conditions that will apply to the shares held by the minority shareholders.
What is the difference between tag along and drag along rights?
Tag-along or co-sale rights are essentially the opposite of drag-along rights. Whereas tag-along rights give minority shareholders negotiating rights in the event of a sale, drag-along rights force the minority shareholders to accept whatever deal is negotiated by majority shareholders.
Are drag along rights common?
In most cases, the controlling majority, or a minimum of 51 percent are allowed to hold a vote to trigger a drag-along the sale. However, 66 percent may be the ideal rate depending on the company. Voters are usually preferred stockholders. Common stockholders might also be included, but this is rarer.
Are drag along rights enforceable?
Drag-along rights are enforceable if the drag-along provision is drafted properly and contained within a valid and enforceable contract, and if the transaction is executed according to the terms of the provision.
What is the purpose of drag along right?
A drag along provision allows the majority shareholder(s) to require the minority shareholder(s) to sell their shares. The aim of drag along rights is to provide liquidity, flexibility and an easy exit route for a majority shareholder.
Can a shareholder be forced to sell shares?
In general, shareholders can only be forced to give up or sell shares if the articles of association or some contractual agreement include this requirement. In practice, private companies often have suitable articles or contracts so that the remaining owner-managers retain control if an individual leaves the company.
Can a minority shareholder sell their shares?
Minority shareholders can still sell their stock in the future to make a profit if the investment is healthy, and can still reap the dividends that the business awards. These benefits do not go away because of the status of the shareholder.
What rights do minority shareholders have?
Minority shareholders have limited rights to benefit from the operations of a company, including receiving dividends and being able to sell the company's stock for profit. In practice, these rights can be restricted by a company's officers' decision to not pay dividends or purchase shares from shareholders.
What is a drag along clause?
A drag along clause enables the majority shareholders of a company (typically over 75%) to compel the minority shareholders to accept an offer from a third party to purchase the whole company.
WHAT ARE LLC drag along rights?
A standard clause in many LLC agreements, a drag-along provision gives a majority member wanting to sell to an unrelated third party all or a substantial percentage of its membership interests in the company the right to force the other members to also sell all or a portion of their membership interests to the third ...
How do you enforce drag along rights?
The first remedy that majority owners can take is to request minority owners to grant an irrevocable proxy. If given, this allows majority owners to act on behalf of minority owners in any vote or action required to effect the sale. It includes signing documents on behalf of the minority owners.
How do tag along rights work?
Tag along clauses are often sought by investors, so that a key shareholder (such as a founder) can't sell its shares unless it finds a buyer willing to buy shares from all shareholders with tag along rights. Often, that means finding a buyer willing to buy the entire company.
What percentage of stockholders can vote on a drag-along?
In most cases, the controlling majority, or a minimum of 51 percent are allowed to hold a vote to trigger a drag-along the sale. However, 66 percent may be the ideal rate depending on the company. Voters are usually preferred stock holders. Common stockholders might also be included, but this is rarer.
What is drag along right?
A drag-along right, drag along provision, or bring along right, is a right that gives majority investors the ability to sell a company to a third-party without consent from minority shareholders. This helps protect the majority and eliminate the minority. However, minority shareholders still receive an equal sales price, terms, ...
Do minority shareholders get equal rights?
However, minority shareholders still receive an equal sales price, terms, and conditions as the majority. In a sale, the drag along agrees to sell the entirety of the stock they own. In a structured merger, the minority shareholder agrees to vote in favor of the merger. Drag along rights are often written in a term sheet, ...
Can preferred stockholders convert to common stock?
Preferred stockholders can also convert some of their stock to common to create a majority vote for a drag-along. This actually isn't a terrible thing for common stockholders, as it lowers the liquidation preference of the stockholder.
Can a drag-along right cause a freeze-out?
It should be noted that a drag-along right that allows investors to force a sale is in some cases a detriment. In rare cases, minority shareholders have blocked the sale of a company by renegotiating terms. Minority shareholders can also hold up transactions approved by the super-majority, causing a freeze-out of a merger.
Can you sell private stocks with drag along rights?
If you're looking to buy a company that has drag-along rights, remember that there is no marketplace to sell private stocks . This forces you to shop it around on your own dime if you wish to sell in the future.
Can minority shareholders freeze out mergers?
Minority shareholders can also hold up transactions approved by the super-majority, causing a freeze-out of a merger. Although drag along rights protects majority shareholders, they also aid minority shareholders. Because the sale price, terms, and conditions are the same as the majority, minority shareholders can get a cut ...
What is drag along rights?
Drag Along Rights (also referred to as “drags” or drag-along provisions) are rights that give the majority owners the right to force minority owners to join in the sale of a company. The rights give the majority owners the ability to sell the entire company based on the terms and conditions. Definitive Purchase Agreement A Definitive Purchase ...
What is a drag along transaction?
From the majority owner’s perspective, a drag along transaction can be triggered by all types of sales: mergers, the sale of substantial assets of the company , sale of company securities, and acquisitions . In most cases, companies include drag along rights in the definition of “transfer”. For example, the term “transfer” may be modified ...
What is the logic behind the drag along?
The logic behind the “dragging along” is that the majority owners have negotiated with the minority shareholders that the former has the right to sell the company, regardless of the form in which the sale is to occur. In the absence of drag along rights, minority shareholders may object to the sale of the company.
Why is the drag along right not enforceable?
The judge held that the drag along right was not enforceable because the majority owners failed to comply with the drag along sale provisions contained in the governing agreement. The majority owners only notified the minority owners of the drag along sale after it had already occurred. The governing agreement required that ...
What is distribution of sales proceeds?
The distribution of sales proceeds of the company is a contentious issue between majority owners and minority owners. Majority owners typically want as much flexibility as possible in negotiating the terms of the sale. They may want to receive payments in the form of cash or other considerations such as securities in the acquiring company. On the other hand, minority owners can be allocated illiquid assets, despite the fact that they want to receive either cash or liquid securities that they can easily convert to cash.
What is a divestment in business?
Divestiture. Divestiture A divestiture (or divestment) is the disposal of company's assets or a business unit through a sale, exchange, closure, or bankruptcy. A partial or full disposal can happen, depending on the reason why management opted to sell or liquidate its business’ resources.
Can minority owners block drag sale?
Sometimes, minority owners may put restrictions on, delay, or block the drag sale from happening. They may impose a black-out period during which a transaction cannot take place. Minority owners may also require a guaranteed minimum price or return over a specified period before the drag right can be effected.
What is a drag along right?
Drag-along right ( DAR) is a legal concept in corporate law. Under the concept, if the majority shareholder (s) of an entity sells their stake, the prospective owner (s) have the right to force the remaining minority shareholders to join the deal. However, the owner must usually offer the same terms and conditions to the minority shareholders as ...
When do drag-along rights terminate?
Drag-along rights typically terminate upon an initial public offering.
What is a share repurchase right?
A share repurchase right in a financial contract gives the right holder the option, but not the obligation, to purchase (or repurchase) a predetermined number of shares at a predetermined price. Share purchase rights are typically offered to existing shareholders to boost management performance and the stock price.
Why do companies issue out share rights?
Companies can issue out share purchase rights to generate the funding they need.
What happens if a product fails to market?
However, if the product goes to market and fails, the shareholder incurs losses. Before exercising share purchase rights, investors should research the company's potential and understand the implications of not exercising share purchase rights in terms of dilution of control.
Why do investors have a call option?
Investors owning a series of share repurchase rights effectively have a call option to re-consolidate their proportional stake in a business. This can be important for investors desiring a control position. Share repurchase rights are usually tied to an equity valuation incentive program.
Is a share purchase rights plan the same as a stock buyback plan?
Share purchase rights are not the same as a share purchase plan or stock buyback where stocks are bought back from the open market. 2:00.
Why are drag along rights called drag along rights?
These rights are called “drag along” because the stockholder group exercising the right are in effect dragging the other stockholders along in the transaction. Why do preferred stock investors in start-up companies ...
What is drag along right?
The drag-along right is usually found in an investor rights agreement, a voting agreement or a stockholder agreement. In effect, the common stockholders are agreeing now that they will in the future go along with the preferred stockholders in a sale of the company.
How does drag along rights work?
How Drag Along Rights Work. If a private company receives an offer to purchase the company, then a majority of the holders of the drag-along rights (usually the preferred stockholders) can notify the company that they approve the deal and that they are exercising their drag along rights. The drag-along rights require all other stockholders ...
What are the key terms of preferred stock financing?
The key terms that are negotiated in preferred stock financings (such as venture capital financings) are: Whether there should be drag-along rights; The timing of when they should be available; A minimum return required for the drag-along to be available; The majority threshold for the holders of the drag-along rights to be able ...
How long does it take for a company to drag along?
Companies will often push for drag-along rights to only start after several years, such as 7 years, to provide the company with enough time to grow before being forced to sell. Investors don’t want any time frame, in order to have maximum flexibility to exercise this right. Minimum Return Requirement .
What happens when a buyer buys a stock?
When a buyer buys the stock of a company, they want to buy 100% of the stock of the company. Legal complications can arise if a buyer acquires less than 100% of the stock of the target company. Big legal complications occur when a buyer acquires less than 90% of the stock of the target company. Drag-along rights ensure that 100% ...
Why don't companies want drag-along rights?
Company founders don’t want drag-along rights, as these rights can be used to sell the company and the founder could then be out of a job. Investors want these rights so they can exit their investment within a reasonable amount of time. Time When Drag-Along Rights are Available .
Triggering Drag Along Rights
- Before majority owners can force minority owners to participate in the sale of the company, they should consider the following issues:
Allocation of Sales Proceeds
- The distribution of sales proceeds of the company is a contentious issue between majority owners and minority owners. Majority owners typically want as much flexibility as possible in negotiating the terms of the sale. They may want to receive payments in the form of cash or other considerations such as securities in the acquiring company. On the other hand, minority owners …
Remedies If Minority Owners Fail to Comply
- Due to the nature of drag sale rights, minority owners may be uncooperative or refuse to comply with the sale procedures. Majority owners may seek to include certain provisions in the drag along right to avert any resistance by the minority owners to the sale. The first remedy that majority owners can take is to request minority owners to grant an irrevocable proxy. If given, this allows …
Related Readings
- Thank you for reading CFI’s guide to drag along rights. To learn more, see the following CFI resources: 1. Sale and Purchase Agreement 2. Capital Structure 3. Divestiture 4. Corporate Structure