What Are Drag-Along Rights?
A drag-along right is a provision 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. Drag-along rights are designed to protect the majority shareholder.
- Drag-along rights are in place during investment negotiations between a company's majority shareholders and minority shareholders.
- Drag-along rights help eliminate minority owners and sell 100% of a company's securities to a potential buyer.
- Although this provision protects majority shareholders from blocked sales, minority shareholders can realize favorable sales terms that may not otherwise be available.
- These are different from tag-along rights, which allow minority shareholders to join a company action with the majority shareholder.
Understanding Drag-Along Rights
A company merger or acquisition (M&A) normally triggers a drag-along right. This provision is important to the sale of many companies because buyers are often looking for complete control of a company, and drag-along rights help to eliminate minority owners and sell 100% of a company's securities to a potential buyer.
Benefits of Drag-Along Rights for Majority Shareholders
Drag-along rights are put in place during investment negotiations between a company's majority shareholder and minority shareholders. 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 that owns 51% of the firm. 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 venture capital firm, giving him the option to force the 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 can block the sale of a company that was already approved by the majority shareholder or a collective majority of existing shareholders. For example, in some cases, although it isn't common, a company shareholder with noncontrolling interest can negotiate a provision that allows him to prevent a liquidation or sale. A company's governing agreements normally outline such rights, and they sometimes require unanimous consent. In these cases, a majority shareholder's drag-along right supersedes the governing agreements and allows him to force a sale of the company.
Drag-along rights typically end when an IPO takes place.
Benefits of Drag-Along Rights for Minority Shareholders
While drag-along rights are meant to protect the majority shareholder of a company, they are also beneficial for minority shareholders. Because this type of provision requires that the price, terms, and conditions be homogeneous across the board, small equity holders can realize favorable sales terms that may be otherwise unattainable.
Tag-along rights protect minority shareholders by giving them the right, but not the obligation, to join in a company action with the majority shareholder. This provision protects the minority shareholder from having to pay separately for an offering, being forced to accept a deal on lesser terms, or being forced to stay a minority holder in a company after the majority sale.
In 2019, Bristol-Myers Squibb Company and Celgene Corporation entered into a merger agreement under which Bristol-Myers Squibb will acquire Celgene in a cash and stock transaction valued at approximately $74 billion.
According to the agreement, Bristol-Myers Squibb majority shareholders will own 69% of the combined entity; and Celgene shareholders will own the remaining 31%. Celgene shareholders will receive one Bristol-Myers share and $50 for each Celgene share.
In terms of drag-along rights, minority shareholders will be "dragged along" in the deal so that the acquiring company can own the majority of shares. Of course, the minority shareholders will receive the same agreement terms as the majority shareholders.