Everything about Drag-along Rights

Saptaswara Chakraborty| North Eastern Hill University| 23rd June 2020 

Introduction

For a sale of a company or even when the entity acquires a company, many at times, a number of obstacles arises which may both be functional as well as bad for the future. Understanding what may be good or bad decides how such a decision would be affecting the company. A majority of times, especially in a share acquisition, acquisition cannot be made without the full consent of all the shareholders. This might create problems for the future a rather lucrative offer might slip off one’s table because a minority portion of the shareholders had denied such an offer. Therefore in order to retain such an offer, a drag-along right is used. In this article, we shall understand what a drag-along right is as contractual mechanisms of investment realizations.

Understanding a drag-along right

Drag along rights give more power to the majority shareholders as they can, therefore, forced upon the minority shareholders to participate in such a sale transaction of the company. This can also be understood as such a right that makes the majority shareholders not to require the consent of the minority shareholders while undergoing any sale transaction. Each merger and acquisition agreements provides the minority shareholders with the right to sell their shares at the same price as that of the majority shareholders along with the provided terms and conditions that the other sellers would possess. As has been mentioned under a drag-along right, it forces the minority shareholders to sell their stocks during such a sale of the company. Such a term is commonly used by the venture capital and the private equity firms. During the sale of such a company, the buyers often tend to or even usually desire of 100% control of the company or even usually desire of such ownership. The goal of such a sale is to bring on board all the majority of such a shareholder and eliminate the minority owners or bring them on the table and get them to agree on to sell the company to such potential buyers. Such a right is often taken up with much caution since the provision of a drag-along right would often implicate their rights in the future sale transactions. In most of the companies or the founders of such a transaction who have been involved in financing or are negotiating finance have come across “Drag-along rights”. While such a right is very much prevalent across, how they are utilized or are instead applied is what decides if such a right is good or bad.

Triggering a drag-along rights

Before the majority of owners can force minority shareholders to participate in the sale of the company. Following issues must be considered:

• Transfer of transactions– From the perspective of the majority owner, a drag-along right or transactions have the capability or can be triggered by various kinds of sales: mergers, sales of substantial assets, sale of company securities and acquisitions in most of the cases.
• Minimum percentage required to trigger the drag-along rights– The minimum percentage that is required to trigger off such ownership is 51%. However, the exact number may vary depending on the ownership mix and the strength of the shareholders.
• Restrictions by the minority owners– Sometimes the minority owners may put up restrictions or even delay the process of drag-sale from happening. They might also require a guaranteed minimum prize of return over the specified period before the drag right can be affected.

Advantages of a drag-along rights

Drag along rights makes it very much more comfortable for the majority shareholders to find a buyer and successfully negotiate a sale because of the assurances that they provide to the potential buyers that once the majority of the shareholders are on board with the transaction, completing the deal will not require any additional shareholder’s consent. An excellent example of this is when technology starts up opens a Series A investment round, so as to sell the ownership of the company to a venture capital firm. In here, the majority of the ownership would reside with the CEO of the company that is 51% of the firm. Under such a situation, the CEO would want to maintain the majority control and would also want to protect himself in case of an eventual sale. The drag-along rights under such a situation would be to prevent any future possibilities in which minority shareholder can block the sale of such a company. Drag-along rights are also very much advantageous for the minority shareholders as they are provided with the benefit of homogeneity as such a provision would require an equal price, terms and conditions across the board and this would help the small equity holders to choose favourable sales terms that might otherwise not be attainable.

Disadvantages of drag-along rights

The primary disadvantage to this right is subjected to the minority shareholders with regards to the forced sale transaction. The minority shareholders would, therefore, limit the circumstances under which such a right can be applicable. Such a right would also make the minority shareholders lose the future profits earned that could have been earned had the company had not been sold. The minority shareholders would, therefore, also not receive a sufficient amount of liquidity for their share. 

Conclusion

A number of companies are adapting to the new norm of the drag-along right because of the surety that it provides to its investors who would want to invest in such a company. Even though the minority shareholders would have to be dragged along but such a method would guarantee much more advantages rather than the disadvantages based on the situation of the company. However, while adapting to such a right, the company so adopting would have to provide for a notice regarding such adoption to the minority shareholders.