What Are Drag-Along Rights?
A drag-along right is a provision or clause in an agreement that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller.
Understanding Drag-Along Rights
Share offerings, mergers, acquisitions, and takeovers can be complicated transactions. Certain rights may be included and instituted with the terms of a share class offering or in a merger or acquisition agreement.
- Drag-along rights may be included and instituted with the terms of a share class offering or in a merger or acquisition agreement.
- Drag-along rights eliminate the current minority shareholders through the sale of 100% of a company’s securities to a potential buyer.
- Tag-along rights differ from drag-along rights since tag-along rights offer the minority shareholders the option to sell but do not mandate an obligation.
The drag-along provision itself is important to the sale of many companies because buyers are often looking for complete control of a company. Drag-along rights help to eliminate the current minority owners and sell 100% of a company’s securities to a potential buyer.
While drag-along rights themselves may be clearly detailed in an agreement, differentiation between majority and minority may be something to watch out for. Companies can have different types of share classes. A company’s bylaws will denote the ownership and voting rights that shareholders have, which may have implications on majority vs. minority.
Considerations for Drag-Along Right Provisions
Drag-along rights can be instituted through capital fundraising or during merger and acquisition negotiations. If, for example, a technology startup opens a Series A investment round, it does so to sell ownership of the company to a venture capital firm in return for capital infusion. In this specific example, majority ownership resides with the chief executive officer (CEO) of the company who owns 51% of the firm’s shares. The CEO wants to maintain majority control and also wants to protect himself in the case of an eventual sale. To do so, he negotiates a drag-along right with the share offering to a venture capital firm, giving him the right to force the venture capital firm to sell its interest in the company if a buyer ever presents itself.
This provision prevents any future situation in which a minority shareholder may in any way be able to undermine the sale of a company that was already approved by the majority shareholder or a collective majority of existing shareholders. It also leaves no shares of the acquired company behind in the hands of previous shareholders.
In some cases, drag-along rights may be more popular in agreements involving private companies. Drag-along rights from privately held shares may also end when a company goes public with a new share offering agreement. An initial public offering of share classes will usually nullify previous ownership agreements and institute new drag-along rights if applicable for future shareholders.
Benefits of Drag-Along Rights for Minority Shareholders
While drag-along rights are meant to mitigate minority shareholder effects, they can be beneficial for minority shareholders. This type of provision requires that the price, terms, and conditions of a share sale be homogeneous across the board, meaning small equity holders can realize favorable sales terms that may be otherwise unattainable.
Typically, drag-along right provisions mandate an orderly chain of communication to the minority shareholders. This provides advance notice of the corporate action mandated for the minority shareholder. It also provides communication on the price, terms, and conditions that will apply to the shares held by the minority shareholders. Drag-along rights can be nullified if the proper procedures surrounding their enaction are not followed.
Drag-Along Rights vs. Tag-Along Rights
Tag-along rights differ from drag-along rights, though they have the same underlying focus. Tag-along rights similarly may be found in share offerings as well as merger and acquisition agreements. Tag-along rights offer minority shareholders the option to sell but do not mandate an obligation. If tag-along rights exist, it can have different implications for the terms of a merger or acquisition than would be discussed with drag-along rights.
In 2019, Bristol-Myers Squibb Company and Celgene Corporation entered into a merger agreement under which Bristol-Myers Squibb acquired Celgene in a cash and stock transaction valued at approximately $74 billion. Post-acquisition, Bristol-Myers Squibb accounted for 69% of shares for the combined entity and converted Celgene shareholders accounted for the remaining 31%. Celgene’s minority shareholders were not allowed any special options and were required to comply with the receipt of one Bristol-Myers share and $50 for each Celgene share owned.
In this deal, the Celgene shares were delisted. The minority shareholders were required to comply with the terms of the deal and were not eligible for special considerations. Had Celgene’s shares not been delisted, drag-along and tag-along rights could have become more of a factor. In some situations such as this, majority shareholders may negotiate special share rights under an alternative class structure that may not be available to minority shareholders due to the implications of drag-along rights.
View more information: https://www.investopedia.com/terms/d/dragalongrights.asp