Updated: April 6, 2022
WHAT ARE “DRAG-ALONG” AND “TAG-ALONG” RIGHTS?
Suppose that you own some shares in a corporation (or membership units, which are like shares of stock of a corporation), but your business partner holds the majority of shares. Now suppose your business partner gets an offer to sell those majority shares to a third party. Even if you don’t want to, you might be obliged to sell your shares, too, if that Shareholders’ Agreement (or an Operating Agreement for LLCs) you signed includes a drag-along provision.
A drag-along provision enables a majority shareholder to force a minority shareholder to join in the sale of a company. In such event, the majority shareholder must give the minority shareholder the same price, terms and conditions as any other seller. Drag-along rights are normally triggered in the event of mergers and acquisitions and are designed to protect majority shareholders.
Alternatively, a partnership agreement can give the shareholders tag-along rights. Tag-along rights allow shareholders to “tag-along” with the majority sale and sell their stock when another shareholder receives a sale offer. Tag-along rights do not require a minority shareholder to sell; they simply give shareholders the option to tag-along and sell their shares along with the majority shareholder. If there is a majority or controlling shareholder who finds someone that will buy their position, the minority can, if they choose, tag-along and sell some of their shares to receive that same premium majority price as well. Tag-along rights, however, must be negotiated for by the minority shareholders.
HOW WILL I KNOW IF THESE RIGHTS AFFECT ME?
Look at your partnership agreement. While the decision to drag or tag can vary from company to company, some basic principles apply to both types of rights. For example, co-owners generally need to give notice before dragging or tagging. If a majority owner doesn’t give notice of the sale to his co-owners, then his dragging or tagging attempt could fail.
Business partners should also examine what triggering events might cause a partner to enforce dragging or tagging rights. If a “transfer” triggers a drag along, then the minority might have to sell any time the majority shareholder chooses to sell any amount of its shares. But if a “change of control” triggers, the minority can hold onto its shares so long as the majority isn’t giving up control of the company.
CAN I PREVENT SOMEONE FROM DRAGGING OR TAGGING ME ALONG?
Simply put, not if your partnership agreement allows for it. Unless your partnership agreement specifically grants you protection, then you might be bound to what your business partner is willing to sell their shares for. For example, even if you disagree about at what price the majority is selling their shares, you might be dragged along to sell at the same price. If your co-owner wants to tag along with your sale, he or she can do so as well.
CONCLUSION
Drag-along and tag along rights may not be the first thing on your mind when beginning a business relationship, but they can impact your plans down the line if you don’t exercise caution when drafting or signing related agreements. It is best practice to consider consulting a lawyer when forming or updating any partnership agreements you may be a party to, to ensure your understanding of your rights.
