Drag along clauses within shareholders' agreements
Drag along provisions (also known as a bring along provisions) are becoming more and more common in shareholder agreements. In this article we explore what they are and how they can work.
At the end of this article are links to further information.
What is a drag along clause?
A drag along provision forces a shareholder to sell his shares on the same terms as the majority of shareholders who approve of the sale. Effectively, the provision prevents minority shareholders from refusing to sell their shares if a buyer who wants total ownership of the company makes an offer to a majority shareholder.
A drag along clause is usually negotiated into a shareholders' agreement by an institutional investor such as a business angel, venture capital investor or private equity investor for whom exit from the investment is of particular importance. Institutional investors usually take a significant stake in a company when they invest, and usually want to be in a position to sell at a profit within two to six years. Although they may sell to another institutional investor, more often they will sell to a "trade buyer" - a competitor company to the one being sold, or a company in a similar industry.
Most trade buyers of majority shareholdings do so in order to be able to change the direction of the business they are acquiring. They may wish to merge the company with another they own, sell some or all of the assets of the company, move the company's location, or enter into new products or markets. Even though they have majority control, minority shareholders can still legitimately delay or frustrate plans to change the direction of the company. Therefore most trade buyers want complete control - ownership of all the equity. For a major institutional investor, it is crucial that if they are to be able to sell to a trade buyer, that there is a drag along provision that forces the minority to sell to the trade buyer at the same time.
Who may trigger the drag along
Usually, the party or parties who trigger the drag along are the ones who benefit from doing so. How they are identified and the threshold of cooperation needed with other parties can be varied from agreement to agreement. Commonly, if a majority of ordinary share holders votes in favour of the sale, then owners of all other classes of stock must also sell (as well as the minority ordinary share owners). The majority could be defined as 51%, 75% or any other amount. However, it is possible for another class of shareholders to drag along ordinary shareholders, so a majority vote by preference shareholders could trigger the drag. Option holders may also be able to drag or be dragged. Sometimes, the trigger is conditional on the additional approval of the board of directors (although involving the board in such an important issue can cause conflicts of interest with the directors' duty of care to the company and to all shareholders).
One of the reasons why some shareholders may be against a sale is that they would receive little or no money for their shares. Therefore, minority shareholders may negotiate a minimum price, a minimum profit or a preferential price into a shareholders' agreement. This could be done on the basis of the valuation of a single class of share, or on the basis of the valuation of the whole company (all classes). Some would say that allowing a minimum price defeats the purpose of the drag along provision since it prevents the sale under certain conditions. However, it can redress some power back to the minority, which may be a small concession to make for the sake of the inclusion of the provision.
Limitation of how payment is made
Often at merger, even if the acquiring company is listed on a stock exchange, there can be a limit to how quickly shares used to fund the purchase are sold. As a result, minorities who dissented to selling but who were dragged along can find themselves with illiquid stock that they don't want. The drag along provision can state that those brought along are entitled to receive cash.
Limitation on representations, warranties and covenants
It is very common for those being dragged along not to be subject to giving representations, warranties and covenants that go beyond ownership and being able to sell.
Futher information and documents
This is one article about the terms that you should include within your shareholders agreement. Other similar articles include:
If you are looking for an agreement, you may be interested in the following version, which includes these clauses: Shareholders agreement: company with shareholder directors and institutional investors.
Or you could choose from our collection of other shareholders agreements.
Please note that the information provided on this page:
- Does not provide a complete or authoritative statement of the law;
- Does not constitute legal advice by Net Lawman;
- Does not create a contractual relationship;
- Does not form part of any other advice, whether paid or free.
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