Drag Along or Tag Along? Shareholder Agreements

A Shareholders Agreement is a critical legal document that governs the relationship between Shareholders and the operation of a company. It sets out the rights, responsibilities, liabilities, and obligations of each shareholder, while also establishing mechanisms to prevent disputes and resolve conflicts efficiently. For business owners, having a well-drafted Shareholders Agreement is essential to ensure the company operates smoothly and remains attractive to investors or potential buyers.

Two commonly used provisions in Shareholders Agreements to help prevent conflict in the case of a proposed sale to a third party are Drag Along and Tag Along provisions. Each serves a distinct purpose in managing the rights and expectations of both Majority and Minority Shareholders during a potential sale of the company to a third party.

What is a Drag Along Provision?

A Drag Along provision allows a Majority Shareholder to compel any Minority Shareholder(s) to sell their shares if the Majority Shareholder receives an offer to purchase the entire company. This provision is designed to facilitate the sale of the company as a whole (rather than just a portion of the company) to the third party, avoiding delays or complications that may arise from Minority Shareholders withholding consent.

Typically, the provision specifies a threshold percentage of shares that the Majority Shareholder (or shareholders in aggregate) must hold to trigger the provision. It also ensures that Minority Shareholders receive the same terms and conditions as the Majority Shareholder, protecting them from being unfairly disadvantaged in the transaction.

What is a Tag Along Provision?

Conversely, a Tag Along provision aims to protect Minority Shareholders by allowing them to participate in a sale to a third party by the Majority Shareholder(s). If a third party offers to purchase the Majority Shareholder’s shares, Minority Shareholders may decide to also participate in the sale for the same price and on the same terms as the Majority Shareholder(s). The Majority Shareholder(s) must then ensure that the third party also acquires the Minority Shares on the same terms, otherwise the sale of the Majority Shareholder’s shares will not be authorised by the company.

This provision ensures that Minority Shareholders are not left behind in a company controlled by a new and potentially unfamiliar majority owner. It also allows them to benefit equally from the sale.

Advantages and disadvantages

Key Points to remember when drafting Drag Along clauses

When preparing the Shareholders Agreement, it is important to consider the percentage of shares required to trigger the Drag Along and Tag Along provisions (i.e. an offer to purchase 60% or more of the shares).

It is also important to ensure the Drag Along and Tag Along provisions do not conflict with the usual share transfer provisions in the Shareholders Agreement (particularly in respect of pre-emption rights of the Shareholders).

Drag Along and Tag Along provisions are powerful tools that help balance the interests of Majority and Minority Shareholders. Clear and precise drafting when preparing the Shareholders Agreement is necessary to ensure their effectiveness and appropriateness for the company.

If you are considering implementing or reviewing your Shareholders Agreement and wish to include Drag Along and Tag Along rights, our Corporate & Commercial Team can provide tailored legal advice to ensure your agreement supports your business goals and protects shareholder interests.