When agreements such as terms sheets are drafted, one of the main areas that are discussed and outlined is the eventuality of an exit. Clauses such as Tag-Along and Drag-Along Rights are common ways of protecting the interests of all shareholders involved.
Specifically, Tag-Along Rights (commonly referred to as “co-sale rights”) are designed to protect minority shareholders during a sale. In fact, if a majority shareholder decides to sell their stake, a Tag-Along clause gives minority shareholders the right to join the transaction, forcing the parties to include minority holders in the negotiations for the sale.
Understanding Tag-Along Rights
Tag-Along Rights are pre-negotiated and typically included in a minority shareholder’s initial issue of a company’s shares. These rights allow the minority shareholder to sell their shares, if a majority shareholder is negotiating a sale.
This has great importance, especially in a start-up context, where majority shareholders – often financial institutions or other high-profile late-stage investors – typically benefit from a much more convenient position when trying to find buyers and negotiate payment terms. It can be, indeed, very hard to sell shares of private companies, with secondary sales being very uncommon as opposed to the issuing of new shares or M&A.
Tag-Along Rights In Practice
Anyone buying a minority stake – or selling a majority stake – in a private company should make sure that you are granted some sort of Tag-Along Rights.
This typically applies to co-founders and early-stage Angel Investors, who benefit greatly from the network and bargaining power of later-stage investors who come on board acquiring larger stakes in the company. If these investors are focused on the sector where the company operates, they will probably go through less trouble than the other stakeholders would in sourcing buyers. Additionally, their position will allow them to negotiate more favourable terms for the sale, and Tag-Along Rights allow minority stake holders to benefit from those same terms as well.
Tag-Along Rights are usually complemented by Drag-Along Rights, which conversely protect majority shareholders.