What Are Drag-Along Rights?
A drag-along right is a right 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 Explained
A drag-along right is normally triggered in the event of a company merger or acquisition. 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, who 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 has the ability to 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 non-controlling interest is able to negotiate a provision that allows him to prevent a liquidation or sale. Rights like this one are normally outlined in a company's governing agreements, 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.
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.
- Drag-along rights are put in place during investment negotiations between a company's majority shareholders and minority shareholders.
- Drag-along rights help to 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 otherwise not be available.