What Are Drag-Along Rights Meaning Benefits and Example
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Drag-Along Rights: Meaning, Benefits, and Example
Evan Tarver has over 6 years of experience in financial analysis and 5 years as an author, editor, and copywriter.
Drag-Along Rights Explained
Drag-along rights allow a majority shareholder to compel a minority shareholder to participate in the sale of a company. The majority owner must offer the same price, terms, and conditions to the minority shareholder as to any other seller.
Understanding Drag-Along Rights
Share offerings, mergers, acquisitions, and takeovers can involve complex transactions. Share class offerings and merger or acquisition agreements may include specific rights and provisions.
Key Takeaways
- Drag-along rights can be part of a share class offering or merger/acquisition agreement.
- These rights allow the majority owner to sell 100% of the company by eliminating minority shareholders.
- Drag-along rights are different from tag-along rights, which give minority shareholders the choice to sell.
Drag-along rights are crucial for selling a company, as buyers often seek full control. These rights help eliminate minority owners and sell 100% of the company’s securities to potential buyers.
While the details of drag-along rights may be outlined in an agreement, it’s essential to distinguish between majority and minority shareholders. Companies may have different share classes, and bylaws determine ownership and voting rights, which can impact majority/minority classifications.
Considerations for Drag-Along Rights
Drag-along rights can be established during capital fundraising or merger and acquisition negotiations. For instance, in a Series A investment round, a technology startup may sell ownership to a venture capital firm. The startup’s CEO—which owns 51% of shares—may negotiate a drag-along right, allowing them to require the venture capital firm to sell its interest if a buyer emerges.
This provision prevents any actions that could undermine a sale approved by the majority shareholder or a collective majority of existing shareholders. It also ensures no shares remain with previous shareholders after the acquisition.
Drag-along rights are more common in private company agreements. However, they may become obsolete if a company goes public with a new share offering—an IPO usually nullifies previous ownership agreements and may introduce new drag-along rights for future shareholders.
While primarily aimed at mitigating the effect on minority shareholders, drag-along rights can benefit them. These provisions require a uniform price, terms, and conditions for all shareholders, enabling smaller shareholders to secure favorable sales terms they may not otherwise achieve.
Drag-along rights typically involve a well-defined communication process with minority shareholders. This provides advance notice and details of the corporate action affecting them. Non-compliance with the specified procedures can invalidate drag-along rights.
Drag-Along Rights vs. Tag-Along Rights
Tag-along rights share a similar focus with drag-along rights but have different implications. Tag-along rights can also appear in share offerings and merger/acquisition agreements, giving minority shareholders the option to sell without obligating them to do so. The terms of a merger or acquisition may vary depending on the presence of drag-along or tag-along rights.
Real-World Example
In 2019, Bristol-Myers Squibb Company acquired Celgene Corporation in a merger valued at approximately $74 billion. After the acquisition, Bristol-Myers Squibb held 69% of shares, while converted Celgene shareholders accounted for the remaining 31%. Celgene minority shareholders did not have special options and had to accept one Bristol-Myers share and $50 for each Celgene share owned.
Though not applicable in this case, drag-along and tag-along rights could have been more significant if Celgene’s shares had not been delisted. In certain situations, majority shareholders may negotiate special share rights that are not available to minority shareholders due to the implications of drag-along rights.
