What are drag-along and tag-along clauses?
Starting a business is an exciting proposition. However, life circumstances may change or shareholding relationships may alter such that you wish to exit the company. It is important to ensure all parties are on the same page from the start as to how you will manage your exit arrangement.
The best place to record this agreement is in a Shareholders' Agreement, which sits alongside a company's constitution and governs the relationship between the shareholders. Shareholding exit arrangements can be complex, but two common types of clauses are ‘drag-along’ and ‘tag-along’ provisions.
Drag-along
Where a majority shareholder wishes to sell their shares to a third party, a drag-along clause provides the majority shareholder with the ability to require minority shareholders to also sell their shares or the business to that same buyer. Put more simply, the minority shareholders can be ‘dragged’ or forced into the sale.
Drag-along clauses are a protection for majority shareholders. Often an incoming purchaser will want complete control of the business and a drag-along clause allows the sale to proceed despite a minority shareholder who is reluctant to sell. Minority shareholders should therefore be weary of such clauses due to the risk they could be forced to sell their shares if the option is exercised.
Tag-along
In contrast, a tag-along clause provides that where a majority shareholder has negotiated a sale of their shares to a third party, that majority shareholder will, at the request of the minority shareholders, endeavour to procure an offer on the same terms for the minority shareholders, i.e. minority shareholders are able to ‘tag-along’ on the sale.
Tag-along clauses are an important protection for minority shareholders as it provides them with an opportunity to possibly exit the company should the majority shareholder decide to sell their shares. In these circumstances, a minority shareholder may not want to be in business with the new majority shareholder.
There are many other important aspects to Shareholders' Agreements. If you would like our assistance to prepare or review a Shareholders' Agreement for your company please get in touch with one of our business law experts today.
