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The terms 'drag along' and 'tag along' or 'drag and tag' are thrown around a lot by fancy lawyers talking about Shareholder Agreements. The terms apply when there a potential sale of shares in a company (i.e. an owner want to transfer his shares to another party).
Drag and tag along rights usually work together with first rights of refusal - the first right of refusal generally applies any time there is a sale or transfer of shares in a company.
There's nothing very complex about them - so check out our explanations about what these terms actually mean.
What is a drag along right?
A drag along right (or drag along option) will be set out in a Shareholder Agreement. A drag along right can exist where a majority shareholder (or a number of shareholders making up a certain majority, say 80%) wants to sell its shares - the majority shareholder can have a drag along right where it can force the remaining 20% shareholders to also sell their shares.
A drag along right is a pretty powerful tool for any majority shareholder to have, as it means the majority owner can offer up the entire company to a potential buyer (rather than, say just a majority stake). It is usually possible for a number of shareholders to ‘band together’ to make up that majority number required to force a sale. For example, if there are 5 owners that each have 20% of the shares, and the drag along threshold is 75%, then at least 4 of the owners would have to join forces to exercise that drag along option.
The mechanics of a drag along right can best be demonstrated through an example. There are 10 friends that each own 10% of a vintage record store. They have a Shareholder Agreement that says that if shareholders that own 80% of the shares or more want to sell their shares, they can drag along the shareholders that own the remaining 20% of the shares.
9 of the record store hipsters want to sell their shares in the business. They have received an offer for their shares from Mick Jagger so they’re keen to go ahead with the sale. There is just one shareholder that has been a pain for the others to deal with right from the start - Dave. Dave isn’t too keen on selling his shares because he’s into that whole non-conformist thing and also generally likes to feel like an outsider - he wants to keep owning part of the business because he wants to make it a longer term investment.
Seeing as there is a drag along right in the Shareholder Agreement, the 9 owners who want to sell can ‘drag along’ Dave and force him to sell his shares to Mick Jagger. Dave’s shares will be sold to Mick Jagger on the same terms as the other 9 owners (i.e. at the same price and subject to the same conditions). The other 9 shareholders will have to give Dave a ‘drag along notice’ which will set out the details of the buyer of the shares, the price and other conditions of the sale, notifying him that he has to sell.
What is a tag along right?
A tag along right (or tag along option) is kinda similar to a drag along right but works in the reverse. It will be set out in a Shareholder Agreement.
A tag along right can exist where a majority shareholder (or a number of shareholders making up a certain majority, say 70%) wants to sell its shares - a tag along right is where a minority shareholder can choose to ‘tag along’ with the sale. A minority shareholder can hitch its minority shares on to the sale of the majority shareholders’ shares.
Here’s an example. Simon and Alex start a pizza shop together. Simon owns 70% of the shares and is an ex-pizza chef at a Michelin star restaurant. He makes a killer pizza and pretty much runs most of the business. His mate Alex wanted in on the pizza joint because he was looking to invest some money. He owns 30% of the business and helps out with the accounting.
Simon and Alex have a Shareholder Agreement which says that there is a tag along option where a shareholder wants to sell more than 60% of the shares.
Simon’s chef friend, Steve wants to buy his shares in the business. Simon wants to exit the business to go and sip pina coladas in Costa Rica. So Simon tells Alex that he wants to sell his shares to Steve, and tells him the price. Seeing as Simon is selling more than 60% of the shares in the company, Alex has a tag along right under their Shareholder Agreement.
The tag along option is in Alex’s favour (the minority shareholder) - that means that Alex can now choose whether he wants to stay in the business and keep his shares, or whether he wants to exercise his right to ‘tag along’ with the sale of Simon’s shares. If Alex wants to tag along, then Steve will have to buy Alex’s shares as well as Simon’s shares on the same terms (i.e. at the same price and subject to the same conditions as Simon’s shares).
Check out our Slightly More Complex Shareholder Agreement which includes drag and tag along rights (shit, no link yet - but it's coming soon!).