Drag-Along and Tag-Along Rights: what are they, why are they necessary and how do they affect the valuation of a minority shareholding?

What are Drag-Along Rights?

A drag-along is a provision in a shareholders’ agreement that enables the majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller.

Why are Drag-Along Rights necessary?

They provide liquidity, flexibility and an easy exit route for a majority shareholder. Many buyers of a target company will want 100% control over a business and rarely agree to allow a minority shareholder to retain a minority share. Without them, it would be difficult for a majority shareholder to accept an offer if the minority shareholders were uncooperative and blocked the sale of the company.

How do they affect the valuation of a minority shareholding?

Minority shareholders may be able to insist on a minimum price level in order to avoid having to sell at an undervalue and want a mechanism in place to verify that the price offered for the shares has been fairly valued and is above the minimum price level.

What are Tag-Along Rights?

A Tag-Along is a provision in a shareholders’ agreement that offers the minority shareholders the option to sell but, unlike the drag-along clause, it does not mandate an obligation.

Why are Tag-Along Rights necessary?

They provide protection to minority shareholders from being left behind when a majority shareholder decides to sell their shares. If a minority shareholder held 10% of the shares in a company, it would be difficult to sell, as most buyers will want 100% of the company and not 10%. This puts minority shareholders at risk of being forced to sell their shares at a price which is substantially much lower or has no relationship to the actual value of the company. Without tag-along rights, shareholders may find that they hold unsaleable or devalued shares.

How do they affect the valuation of a minority shareholding?

In delivering a larger controlling stake to the prospective purchaser, such tag-along rights may potentially secure a higher share valuation for a minority shareholding.

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