Basics of Equity Tag-Alongs and Drag-Alongs

Since equity often equates to ownership in a company, the sale of equity can have many implications. We’ve previously covered the basics of the Right of First Refusal (RoFR), in which companies try to protect against ownership dilution by having the ‘first refusal’ of a third party sale by purchasing shares in their place. This week, we’ll look at tag-along and drag-along rights, which involve joining a sale to a third party instead.

What is a Tag-Along Right?

Also known as a co-sale right, shareholders with this right are allowed to join any sale to a third party and effectively stop that sale from happening if the third party refuses to purchase their additional shares. Let’s take a look at an example:

1. Shareholder A receives a third party offer to purchase their 15% stake in the company.

2. Tag-along rights give other shareholders the option, but not the obligation, to join and sell their stakes on the same terms.

3. After a 30-day notification period, Shareholder B decides to join and sell their 5% stake.

4. The third party must agree to either buy 20% of the company, or the sale cannot proceed.
   
   

Implications of Tag Along Rights

You might notice some similarities to the Right of First Refusal (RoFR) in that it’s designed to protect existing shareholders without fully blocking third party sales. It’s not uncommon to see a tag-along right nested within or included along a RoFR. In other words, if the company chooses not to purchase your share in place of the third party, they are instead able to 'join' and sell a similar stake as you to the third party.

Zooming out to cases of a transfer of company ownership, tag-along rights go a step further by enabling minority shareholders to take advantage of good deals that majority shareholders may be able to negotiate. In an effort to make a successful sale, majority shareholders are incentivized to include favorable terms for minority shareholders so they participate. Of course, the possibility of tag-alongs may disincentivize third party buyers who aren't interested in purchasing bigger stakes.

What is a Drag-Along Right?

Drag-along rights are the opposite of tag-along rights, in which minority shareholders have no choice but to join a sale of shares to a third party. Let’s take a look at an example:

1. Majority Shareholder A, who owns 60% of the company, receives a third party offer to purchase the company.

2. Shareholder A agrees to sell their stake to the third party, and invokes their drag-along rights to force the remaining 40% of shares owned by minority shareholders to be sold as well.

3. Minority shareholders must agree to the terms already negotiated by Shareholder A, and the company is sold in full to the third party.
   
   

Implications of Drag-Along Rights

Sometimes also known as ‘come-along’ rights, drag-along rights are favorable to majority shareholders since it gives them the option to force a sale through and effectively have control over shares they don’t own. In other words, drag-along rights offer protection to majority shareholders since minority shareholders must ‘come along’. Given the severity of these rights, minority shareholders will often negotiate terms that protect against a bad deal, such as a minimum price and cash-only payments.

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While these clauses are typically negotiated by founders and other larger shareholders of a company, we felt it was important for all employees to be aware of their implications. Of course, the details of these rights can differ greatly from one contract to another. They may not kick in unless a certain percentage of shares are sold, they may not require the same warranties and obligations to dragged-along shareholders, and they often only apply to cash deals so shares aren’t converted to something potentially less liquid and/or valuable. As always, read the fine print to prepare for all conditions!

For advocacy and beyond,
The Ask Ginkgo Team