Drag along rights: Delivering a clean exit
A drag along right enables a specified majority of shareholders, or a specified investor majority, to require the remaining shareholders to transfer their shares where that majority has accepted an offer from a third-party buyer. The commercial purpose is to ensure that the majority can deliver a clean exit, usually by enabling the buyer to acquire 100% of the issued share capital. Without an effective drag along provision, minority shareholders could withhold consent, delay completion or frustrate a sale which has otherwise been approved by the requisite majority.
Investor and management tensions
In a private equity context, drag along rights can give rise to tension between financial investors and management shareholders. Investors may be working to a defined investment horizon and will want to ensure that minority holdings do not prevent a trade sale, secondary buyout or other liquidity event. Management shareholders may be concerned that they could be required to sell at a time when they consider the business has not yet reached its full value, or before they have fully benefited from incentive, ratchet or rollover arrangements.
A drag along right should also be distinguished from the statutory squeeze-out procedure under the Companies Act 2006. A statutory squeeze-out is a compulsory acquisition mechanism available in prescribed circumstances following a takeover offer – the requirement for there to be a takeover offer means it is most commonly used in the context of publicly listed companies. By contrast, a drag along right operates because the shareholders have agreed to it in the company’s constitutional or contractual documents and so is a mechanism for private companies to utilise without the requirement for there to be a statutory 'takeover offer'. Its enforceability and practical effect therefore depend on the precision of the drafting, including the trigger threshold, notice procedure, transfer mechanics and remedies for non-compliance.
Tag along rights: Protecting minority shareholders
Tag along rights operate as a minority protection. They give minority shareholders the right, where the majority proposes to sell its shares to a buyer, to require the selling shareholders to procure that the buyer also purchases the minority shareholders’ shares. These rights are usually drafted so that the minority participates on the same terms, and for the same price per share, as the selling majority, subject to any agreed differences arising from share class rights or management incentive arrangements. To contrast with the drag along rights, tag along rights do not require the minority to sell their shares – they are a tool for them to utilise should they wish to sell.
This protection is important because a minority shareholder may not wish to remain invested following a change of control. Without a tag along right, a minority holder could be left in the company with a new controlling shareholder, limited voting influence and a reduced ability to exit its investment on equivalent economic terms.
The two rights therefore serve distinct but complementary purposes. Drag along rights support the majority and the buyer by facilitating an orderly sale of the entire share capital, whereas tag along rights protect minority shareholders from being left behind on a change of control. In practice, they are usually negotiated together so that the majority has sufficient flexibility to achieve an exit, while minority shareholders receive appropriate economic and procedural protection.
Additional considerations:
In private equity transactions, these rights should be considered alongside the wider investment structure. They should be consistent with investor consent rights, leaver provisions, permitted transfer provisions, pre-emption rights, reserved matters and any management rollover arrangements. If the articles, shareholders’ agreement and investment agreement are not aligned, there may be uncertainty as to whether shareholders can be compelled, or are entitled, to participate in a sale on the intended terms. This can create execution risk at the point of exit, when certainty and speed are usually critical.
From a drafting perspective, the provisions should clearly address:
- the threshold for triggering the right, such as a simple majority, 75% majority, investor majority or class consent threshold;
- the transfer mechanics, including the contents and timing of notices, completion timetable, execution of stock transfer forms and any power of attorney or deemed transfer mechanism for a defaulting shareholder;
- minority protections, including any minimum price, same consideration, same terms, pro rata treatment and limitations on warranties, indemnities or restrictive covenants required from minority sellers;
- whether the purchaser must be a bona fide third-party purchaser acting at arm’s length and whether related-party or intra-group transfers are excluded;
- how the rights interact with pre-emption rights, leaver provisions, permitted transfers, investor consent rights and management rollover arrangements.
In summary, drag along and tag along rights are key exit provisions in private company and private equity arrangements. Drag along rights promote transaction certainty by enabling the requisite majority or investor group to deliver the whole company to a buyer. Tag along rights protect minority shareholders by enabling them to participate in a majority sale on equivalent terms. When drafted clearly and aligned with the wider investment documents, these rights provide a practical framework for managing share transfers, reducing execution risk and balancing majority control with minority protection.
Thank you to our authors Vicky Thomas and Beloved Ogundipe
