Understanding drag along and tag along rights - a simple guide

What are drag along / tag along rights?

Drag along / tag along rights can be an important way of providing shareholders with additional rights and protections, but what actually are they?

• Drag-along rights: drag-along rights allow majority shareholders to force minority shareholders to join in the sale of the company. They are often included in shareholders' agreements to ensure that in a share sale situation, the sale can proceed smoothly without minority shareholders stopping the sale or demanding a higher price than the one that the majority shareholders have negotiated. Including a drag along clause can prevent minority shareholders from obstructing or hindering a sale transaction that the majority of shareholders intend to proceed with; and

• Tag-along rights: tag-along rights are a provision in a shareholders' agreement that protects minority shareholders in the event that majority shareholders want to sell their shares. The rights provide protection for minority shareholders by allowing them to "tag along" with the sale and sell their shares at the same price (and on the same terms) as majority shareholders. A tag along clause is often included in a shareholders' agreement to protect minority shareholders from being left behind (with unknown third parties) when majority shareholders sell their shares.

What is the process for exercising drag along and tag along rights?

The specific process that will need to be followed in order for a shareholder to exercise their drag along / tag along rights will depend on the company’s documents, but typically it will include the following:

• Drag-along rights: the drag along clause will set out the number of shares (as a percentage) in the company that a shareholder must hold in order to be able to exercise a drag along right, as well as the minimum number of shares that must be being transferred in order to invoke the drag along clause. To exercise drag along rights, the majority shareholder must give notice to the other shareholders, and that notice will usually specify: (i) that the other shareholders are required to transfer all of their shares; (ii) the person to whom the shares are to be transferred to; (iii) the purchase price payable for the shares which will be an amount at least equal to the price per share offered by the buyer for the majority shareholder’s shares; and (iv) the proposed date of the transfer of the shares.

• Tag-along rights: the selling shareholders must notify the other shareholders in the company of the proposed transfer, and offer to buy the shares held by them for a consideration in cash per share that is at least equal to the price per share offered by the buyer under the proposed sale. The offer will need to be made no later than a specified period prior (agreed between the shareholders) to the proposed sale, and would usually include: (i) the identity of the proposed buyer; (ii) the proposed price for the sale and other terms of payment; (iii) the date of completion of the sale; and (iv) the number of shares proposed to be purchased by the buyer. If a tag along clause is included and the selling shareholder fails to follow the process, its proposed sale may be void.

When exercising drag along / tag along, make sure you always check the specific process that has been set out in your company’s documents (i.e. shareholders' agreement and articles of association).

How can Docue help?

Docue’s dynamic shareholders' agreement includes the option to include provisions relating to drag along / tag along. The tag-along clause and drag-along clause can be customised to suit your requirements, by simply answering a series of questions. As you answer the questions, the shareholders' agreement will be automatically updated to suit your needs, including by containing drag-along / tag-along rights if required.

Sign up to Docue today to use our shareholders' agreement template.