Drag along rights explained: how majority shareholders force a sale, and the pros and cons

What are drag along rights, and should you put them in your company's documents? In short, a drag along clause lets majority shareholders force the minority shareholders to sell their shares to a third-party buyer at the same time as them. Whether you want one depends largely on which side of the table you sit: majority shareholders usually want drag along rights, and minority shareholders usually worry about them.

What are drag along rights?

Drag along rights are contractual provisions, usually found in a shareholders' agreement or in the company's articles of association, that enable majority shareholders to force minority shareholders to sell their shares to a third-party buyer. The majority literally drags the minority along into the sale.

Here is how it works in practice. A majority shareholder receives an offer for their shares. Rather than selling only their own stake, they exercise the drag along rights and require the minority shareholders to sell their shares to the same buyer as well.

Why would a majority shareholder want this? Because if they want to sell the whole company, and the buyer wants to buy the whole company, they do not want to rely on the hope that the minority shareholder will be willing to sell, and willing to sell at that price. By putting a drag along provision in the company's documents at the outset, the majority shareholder removes that uncertainty. If a sale comes along, they can require the minority to join it.

A simple example makes the point. Say you own the majority of the shares in your company and a smaller shareholder owns the rest. A buyer approaches you and wants the whole company. Without a drag along clause, the buyer's offer depends on your co-shareholder agreeing to sell, and agreeing to the price. That gives a small shareholder a surprising amount of leverage over a deal they did not negotiate. With a drag along clause, you accept the offer, serve the drag along notice in accordance with the documents, and the minority shareholder is required to sell on the same terms.

Because they are contractual, drag along rights only exist if they have been written into the shareholders' agreement or the articles. They are not implied. If your documents are silent, there is no drag along right to exercise, however large your shareholding.

Drag along vs tag along rights

Drag along rights have a sister provision: tag along rights. People often confuse the two, so it is worth setting them side by side.

Tag along rights work in the opposite direction. In short, they enable minority shareholders to veto a share sale by a majority shareholder unless the buyer also offers to buy the minority shareholders' shares on the same terms. The minority can "tag along" and sell with the majority.

There are three key differences between the two:

• Who benefits. Tag along rights benefit minority shareholders. Drag along rights benefit majority shareholders.
• Option versus obligation. Tag along rights give minority shareholders the option to sell their shares to the buyer. Drag along provisions force minority shareholders to sell their shares to that buyer.
• Purpose. Tag along rights exist so that minority shareholders are not left behind with a stranger as their new majority shareholder. Drag along rights exist so that a potential business sale is not put at risk, because a buyer of a business usually wants to buy all of the shares in the company, not just those held by the majority.

The two provisions are not alternatives. They deal with the same event, a sale of the majority's shares to an outsider, but from opposite perspectives. One gives the majority certainty that they can deliver the whole company. The other gives the minority certainty that they will not be stranded. If you want the minority-shareholder side of this in more depth, there is a separate page on tag along rights.

Advantages of drag along rights

There are three main advantages that I can think of, and they all flow from the same point: a buyer usually wants 100% of the shares.

• Lower risk of the buyer walking away. With drag along rights in place, the majority can drag the minority into the sale whether they want to sell or not. The risk of the buyer being unable to acquire the entire company is virtually eliminated, so there is typically a much lower risk of a buyer abandoning the purchase because a minority shareholder refuses to sell.
• An easier completion for the buyer. The buyer does not have to liaise and negotiate separately with each of the company's shareholders. There is one negotiation, with the majority, and everyone else follows. That reduces the buyer's risk and effort, which is exactly why a seller can be in a stronger position on price.
• Potential for a higher valuation. Because the buyer is taking on less risk, they may be willing to pay more for the business. A single, clean negotiation for the whole company supports a better price than a fragmented one.

Disadvantages of drag along rights

Drag along provisions are not free of downsides, and you should go in with your eyes open.

• Unhappy minority shareholders. A minority shareholder who is forced to sell may not be happy about it, and an unhappy minority shareholder may bring an unfair prejudice claim. The drag along clause reduces the risk to the sale, but it can create friction between the shareholders themselves.
• Procedural burden and professional fees. Exercising drag along rights is a formal process. Solicitors will usually be involved to help put the provisions into effect, and that increases costs. The clause is only useful if it is operated properly, so the notice and the mechanics need to be followed to the letter.
• It may put off investors. An investor considering a minority stake in your company will read the shareholders' agreement and the articles. If they see drag along provisions that can be enforced against them, that may discourage them from investing at all, or lead them to negotiate harder on the terms. Investors know that a drag along means their exit timing and price can be decided by someone else.

Should you include drag along rights?

That is how drag along rights work in practice. In my experience the answer to "should we include them?" depends on who you are and what you expect to happen to the company.

If you are, or expect to be, a majority shareholder who may one day sell the whole business, drag along rights protect the deal you will eventually want to do. If you are a minority shareholder or an incoming investor, you will want to understand exactly how the drag along can be triggered, on what terms, and whether you have matching tag along protection. Many shareholders' agreements contain both, so that each side is protected.

Next steps

Check your shareholders' agreement and articles of association to see whether they already contain drag along or tag along provisions, and how they are triggered. If you are drafting new documents, or bringing in an investor, speak to a corporate solicitor about whether drag along rights suit your position and how they should sit alongside tag along rights.