Tag-along rights, sometimes known as ‘co-sale rights’, are contractual obligations designed to protect minority shareholders, particularly in venture capital deals. When a majority shareholder sells their stake, these rights allow minority shareholders to join the transaction and sell their shares at the same terms. Tag-along rights ensure that minority holdings are included in negotiations, enabling them to benefit equally.
Key Points to Know
- Investor Protection: Tag-along rights safeguard the interests of minority investors in startups and private firms.
- Sale Considerations: Ensure minority stakes are acknowledged during company sales.
- Increased Liquidity: These rights offer greater liquidity to minority shareholders.
- Equity and Fairness: Minority investors sell their shares under the same price and conditions as the majority investor.
- Potential Challenges: May complicate the selling process due to increased negotiation requirements.
Understanding Tag-Along Rights
Tag-along rights are often integrated into the initial stock issuance to minority shareholders. If a majority shareholder decides to sell their stake, these rights allow minority shareholders to join in and sell their shares too. These rights are especially common in startups and private firms with high growth potential.
Tag-along rights give minority shareholders the chance to benefit from deals orchestrated by major shareholders, who often have better resources to find buyers and negotiate terms. As private equity shares are not easily sold, these rights bring crucial liquidity. Majority shareholders often facilitate deals in the secondary market, benefiting smaller shareholders.
Moreover, under most corporate laws, majority shareholders owe a fiduciary duty to minorities, requiring them to act in good faith and honesty.
Benefits and Drawbacks of Tag-Along Rights
Advantages:
- Protect minority shareholders, including employee stockholders, providing both financial and legal safeguards in a company sale.
- Empower minority shareholders to receive similar benefits as majority investors during sales.
- Decrease the risk for minority shareholders by aligning their exit terms with those secured by the majority.
Disadvantages:
- May deter potential majority investors who do not wish to be encumbered by these obligations.
- Require concessions from both management and large shareholders, potentially enhancing the challenges of orchestrating a deal.
Tag-Along Rights in Action
Suppose three co-founders start a tech company, which then attracts the interest of an angel investor who purchases a 60% stake. Knowing the investor’s influence in the tech sector, the co-founders smartly negotiate tag-along rights.
Years pass, the company grows, and the investor seeks to sell their 60% stake for $30 per share. The co-founders, thanks to their tag-along rights, can sell their shares at the same price and under the same conditions, ensuring equitable returns.
FAQs on Tag-Along Rights
What is the Difference Between Tag-Along Rights and Drag-Along Rights?
While tag-along rights provide minority shareholders the option to join in a sale, drag-along rights compel them to partake in the sale under the terms negotiated by the majority shareholders.
Do Tag-Along Rights Facilitate or Impede Selling Shares?
Tags-along rights may complicate the sale process if potential buyers are unwilling to meet the conditions required by minority shareholders.
What is a Come-Along Clause?
Also known as drag-along rights, come-along clauses require minority shareholders to sell their shares once the majority shareholders decide to sell. This is in stark contrast to the protection offered by tag-along rights.
Related Terms: venture capital, minority shareholders, fiduciary duty, drag-along rights.
References
- Rocket Lawyer. “Drag Along and Tag Along Rights”.
