Navigating a Shareholders Agreement – Part 2 – Drag Along and Tag Along Right

One of the main aspects of a shareholders agreement for an investor is the mechanism through which the investor will be able to sell his shares and see the colour of money.

Part 2 of this knowledge series covers the mechanism of Drag Along Right and Tag Along Right which are important mechanism pertaining to the exit rights of the investor.

Drag-Along Right

In some cases a selling shareholder may not be able to sell his shares to a prospective buyer as the quantum of shareholding of such selling shareholder may not be attractive to a prospective buyer. This is common in case where the selling shareholder has a relatively smaller shareholding in the company. A prospective buyer may be amenable to purchase shares of the selling shareholder provided that such prospective buyer is able to achieve a larger shareholding percentage in the company. In such cases if the selling shareholder holding the Drag Along Right (“Drag Right Holder”) does not hold the requisite number of shares as required by the prospective buyer, the Drag Right Holder in order to facilitate his exit can exercise his drag along right to compel the sale of such additional shares held by identified shareholders (“Dragged Shareholder”) to meet the requirement of the prospective buyer.

Points to be considered by Drag Right Holder:

1. The Dragged Shareholder should be required to provide representations and warranties in relation to his shares as required by prospective buyer.

2. The Dragged Shareholder should be required to tender his shares and complete all sale formalities within a defined period.

3. The Dragged Shareholder should be required to co-operate with the Drag Right Holder and prospective buyer and, provide all information and execute requisite documents to complete the sale of shares.

Points to be considered by Dragged Shareholder:

1. The Drag Along Right should be triggered only after the Drag Right Holder has not been provided an exit in the manner and in accordance with the timelines set out in the shareholders agreement or upon the occurrence of an event of default or a material adverse change.

2. The terms of sale offered to the Dragged Shareholder should be the same as the terms offered to the Drag Right Holder.

3. An upper limit to the number of shares that can be dragged should be set out in the shareholders agreement.

Tag-Along Right

An investment is made into a company, however, the decision to make such investment is based on the trust and relationship with company’s founders, an investor may not want to continue as a shareholder of the company if such founder decides to sell his shares and exit the company. In such cases the shareholder having the tag along right (“Tag Right Holder”) can exercise his right to compel such selling founder (“Tagged Shareholder”) to ensure that the prospective buyer also purchases the shares of Tag Right Holder along with the shares of Tagged Shareholder.

Points to be considered by Tag Right Holder:

1. The terms of sale offered to the Tag Right Holder should be the same offered to the Tagged Shareholder.

2. The Tag Right Holder shall have the right to sell some or all his shares based on the number of shares being sold by the Tagged Shareholder. For instance, in the event wherein the Tagged Shareholder is selling more than majority of his shares in the company, the Tag Right Holder may choose to sell all his shares.

3. The Tag Right Holder should have the right but not an obligation to exercise the Tag Along Right.

Points to be considered by Tagged Shareholders:

1. The tag along right should be triggered only in the event wherein the Tagged Shareholder proposes to sell his shares in excess of the agreed threshold.

2. Tag along right should fall away after the company has achieved certain pre-determined milestones.

3. Only in the event wherein the Tagged Shareholder is selling the majority of shares in the company should the Tag Right Holder be entitled to sell all his shares, in other cases the Tag Right Holder should be entitled to sell his shares on a pro-rata basis.

4. The Tag Right Holder should be required to co-operate with the Tagged Shareholder and , provide all information and execute documents to complete the sale of shares.

You can read Part 1 of this Knowledge Series –  Right of first offer (ROFO) and Right of first refusal (ROFR) here.

You can read Part 3 of this Knowledge Series –  Anti Dilution here.

For more information about the Shareholders Agreement you may write to us at:

solutions@bridgeheadlaw.com.

– Karan Narvekar | Partner

– Sunny Nirmal | Associate

Views expressed are personal to the authors and do not constitute as legal advice.