Drag-along rights are provisions in agreements that allow majority shareholders to compel minority shareholders to join in the sale of a company. This article delves into the intricacies of drag-along rights, their benefits, and how they differ from tag-along rights. We also provide a real-world example to illustrate their application.
What are drag-along rights?
Drag-along rights are a crucial provision in agreements that grant majority shareholders the power to force minority shareholders to participate in the sale of a company. The majority shareholder invoking these rights must ensure that the minority shareholder receives the same price, terms, and conditions as any other seller.
Understanding drag-along rights
Share offerings, mergers, acquisitions, and takeovers can be complex transactions, often involving various rights and provisions. Drag-along rights may be included in the terms of a share class offering or a merger and acquisition agreement. These rights essentially eliminate the current minority shareholders by facilitating the sale of 100% of a company’s securities to a potential buyer.
While the concept of drag-along rights is clear, differentiating between majority and minority shareholders can be tricky, especially in companies with multiple share classes. A company’s bylaws dictate ownership and voting rights, which can impact the distinction between majority and minority shareholders.
Considerations for drag-along rights provisions
Drag-along rights can be implemented during capital fundraising or merger and acquisition negotiations. For instance, a technological startup’s CEO may control 51% of the business’s shares, or majority ownership, if the company is seeking to acquire capital through a Series A investment round. The CEO, keen on retaining control and safeguarding their interests in case of a sale, negotiates drag-along rights with the venture capital firm participating in the share offering.
No minority shareholder may obstruct a sale that the majority shareholder has approved thanks to this clause. It also ensures that no shares remain with previous shareholders after the acquisition.
In some cases, drag-along rights are more prevalent in agreements involving private companies and may cease to exist once a company goes public with new share offerings. An initial public offering often supersedes previous ownership agreements and may introduce new drag-along rights for future shareholders.
Benefits of drag-along rights for minority shareholders
Despite being intended to mitigate the effects on minority shareholders, drag-along rights can actually benefit them. These provisions demand uniformity in the price, terms, and conditions of a share sale, ensuring that small equity holders receive favorable terms they might not have otherwise achieved.
Drag-along right provisions typically establish a structured process of communication with minority shareholders. This includes providing advance notice of the corporate action mandated for them as well as details regarding the price, terms, and conditions that will apply to their shares. However, it’s important to note that failing to follow the proper procedures can nullify drag-along rights.
Drag-along rights vs. tag-along rights
While both drag-along and tag-along rights focus on shareholder participation in sales, they differ in their obligations. Tag-along rights provide minority shareholders with the option to sell their shares but do not mandate such action. This distinction can have significant implications for the terms of a merger or acquisition.
Celgene Corporation and Bristol-Myers Squibb Company merged in 2019, with Bristol-Myers Squibb purchasing Celgene for about $74 billion. Bristol-Myers Squibb owned 69% of the merged company’s shares, and converted Celgene stockholders held 31% of the shares. The minority Celgene shareholders received one Bristol-Myers share and $50 per Celgene share if they followed the deal and had no special choices.
In this case, the Celgene shares were delisted, and minority shareholders had no alternative options. But if the shares had not been taken off the market, drag-along and tag-along rights might have come into play. Minority shareholders may have been unable to secure special share rights under a different class structure due to drag-along rights.
The bottom line
Drag-along rights are a crucial tool in ensuring the smooth sale of a company, providing majority shareholders with the authority to include minority shareholders in the transaction. These rights have benefits for both majority and minority shareholders, and their proper execution is essential for their effectiveness. Understanding the nuances of drag-along rights can be valuable in various business scenarios.
Frequently asked questions
Are drag-along rights common in merger agreements?
Drag-along rights can be found in merger agreements, especially when majority shareholders want to ensure a seamless sale process.
How do drag-along rights benefit minority shareholders?
Drag-along rights ensure that minority shareholders receive the same terms and conditions as majority shareholders, potentially leading to more favorable sales terms.
What’s the difference between drag-along and tag-along rights?
While both focus on shareholder participation in sales, drag-along rights mandate the sale, while tag-along rights offer the option to sell without obligation.
- Drag-along rights empower majority shareholders to compel minority shareholders to participate in a company sale.
- These rights ensure that minority shareholders receive equal terms and conditions, potentially benefiting them.
- Drag-along rights differ from tag-along rights, which provide an option but don’t mandate a sale.
- Proper communication and adherence to procedures are essential to enforcing drag-along rights.
- In some cases, drag-along rights may be more common in agreements involving private companies.
View Article Sources
- Issues and Best Practices In Drafting Drag Along Provisions – Harvard Law School Forum on Corporate Governance
- Drafting of SHA – Institute of Company Secretaries of India
- Understanding Venture Capital Term Sheets – Harvard Business School
- 4 Alternatives To CDs: Ways to Get Better Returns Than CDs – SuperMoney
- Term Sheets: A Comprehensive Guide to Understanding the Basics – SuperMoney