In considering a share sale transaction, a potential seller needs to think about the deal appetite of their fellow shareholders. If you hold the majority of the issued shares, how do you ensure the minority shareholders join in for the sale and provide a streamlined exit? If you hold a minority stake, how do you ensure that you aren’t left behind? In this article, we will explore some of the nuances involved in drag and tag along transactions and how they might impact a share sale transaction.
What is a drag along?
A drag along is a set of clauses usually included in a shareholder’s agreement for a company, which is intended to protect a majority shareholder’s ability to sell the entire company without being hindered by minority shareholders.
If the majority shareholders holding at least a specified percentage of shares in the company have received a genuine offer from a third party wishing to buy the entire company, a drag along clause enables those shareholders to compel the minority shareholders to join the sale and sell their shares to the buyer, as well. Usually, a drag along clause will require that the terms offered to a minority seller must be the same as the terms offered to a majority shareholder – that is, the majority shareholder can’t receive a better deal than the minority shareholder.
What is a tag along?
A tag along is a set of clauses often included in a shareholder’s agreement which is intended to protect minority shareholders. If a majority shareholder receives a genuine offer from a third party for the sale of a specified percentage of the company (for example, 80%), the minority shareholders may exercise their tag along right, which requires the majority shareholder to procure that the buyer also purchases the minority shareholder’s shares.
The purpose of a tag along clause is to provide protection for minority shareholders in the event of a transaction, so that they can participate in and benefit from the transaction on the same terms as offered to the majority shareholder, and also so that the minority shareholders do not end up “stuck” with a shareholding with an unfamiliar third party and limited opportunities to otherwise divest of their shareholding.
Benefits and drawbacks
There are various benefits and drawbacks associated with the inclusion and operation of drag and tag along clauses in a shareholders agreement:
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Advantages
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Disadvantages
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Drag along
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- Provides flexibility for a majority shareholder in ensuring a deal can be done
- Ensures a cohesive and streamlined process in negotiating with a potential buyer
- Facilitates a unified sale process, rather than requiring shareholders to negotiate among themselves regarding a potential sale.
- Reduces legal complexity of a transaction, given majority shareholders’ ability to negotiate terms and provide simplified documentation, rather than having all shareholders negotiate individually.
- Makes a company more marketable to potential acquirers, given the smoother path to acquiring the whole entity.
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- Typical drag along clauses require the terms of sale for shareholders to be the same. This can cause difficulty where a buyer requires various warranties and indemnities to be provided, which may not be appropriate for a minority shareholder.
- The requirement to comply with a drag along provision removes autonomy from minority shareholders in deciding to sell their shares.
- The majority shareholder being able to determine the terms of sale may force minority shareholders to accept terms they consider unfavourable
- The implementation of a drag clause may add legal and or administrative complexity to a transaction, particularly if shareholders contest the clause’s enforcement.
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Tag along
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- Provides protection for minority shareholders against being left out of a transaction
- Promotes equal treatment of all shareholders regardless of their proportionate holding
- Encourages cooperation in a transaction among shareholders and negotiating for their collective benefit.
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- The potential to delay transactions with the addition of further parties and negotiations
- Reduced flexibility for the majority shareholders in negotiations
- Risk of conflict between shareholders as to the terms of a transaction
- Further complexity in the execution of a transaction, given additional requirements of complying with tag along clauses.
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We are here to help
There are a number of ways in which a drag along and tag along clauses can be effectively drafted for the benefit of shareholders, to clearly articulate the rights and obligations of the parties, and to ensure that when the time comes, they are able to be applied in practicality and to assist, rather than hinder, the execution of a transaction.
It is important to seek advice if considering including a drag along or tag along clause in your shareholders agreement, or if contemplating utilising them in a transaction. Proper, informed consideration should be given to applying the clauses to all classes of shares and the appropriate thresholds for each clause, and what the proposed clause will look like when applied in a transaction.
At Russell Kennedy, we regularly draft shareholders agreements for clients with an eventual exit strategy in mind. Our experience with drag along and tag along transactions means we can help you implement drag and tag along provisions in a way which will aid the execution of your future share sale transaction.
If you would like to discuss your shareholders agreement or how a drag or tag along clause might be utilised in your proposed transaction, please contact our Mergers and Acquisitions team