What are Drag-along and Tag-along?
Drag-along and Tag-along are two of the most critical clauses in a shareholders' agreement. They regulate what happens to minority shareholders' equity when the company is acquired. Although they are often mentioned together, they serve two opposite functions: Drag-along protects majority shareholders, while Tag-along protects minority shareholders.
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1. Drag-along (Drag-along obligation)
A drag-along right gives the majority shareholder (or a group of shareholders that form a majority) the right to force the remaining minority shareholders to sell their shares if a buyer wants to acquire the entire company.
Why is this needed?
Most large acquirers want to purchase 100% of the shares in a company. Without a drag-along provision, a single small shareholder could theoretically refuse to sell and hold the entire deal hostage. Through a drag-along, the sale can be pushed through, provided that all minority shareholders are forced to sell on the exact same terms and price per share as the main owners.
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2. Tag-along (Tag-along right)
Tag-along is the counterpart and acts as a protective rule for minority shareholders. The clause ensures that if the main owners (e.g., founders or VC firms) sell their shares to an external buyer, the other shareholders have the right to "tag along" and sell their shares on exactly the same terms.
Why is this important?
If an external party buys the majority of the company and replaces management, the company's future might become uncertain for those left behind. Tag-along protects small shareholders from becoming "locked in" to a company with a new, unknown majority owner, and prevents founders from cashing out at a premium while leaving others with illiquid shares.