Ordinary shares: what they are, plus drag along, tag along and anti-dilution rights

Did you know there is no legal definition of an ordinary share? That has a useful consequence: within reason, you can create any type of share you want. This page covers what ordinary shares usually are, and then the three rights and restrictions I most often attach to a class of shares to make them fit a particular shareholder: drag along rights, tag along rights and anti-dilution provisions. There is also a tip for founders at the end on keeping control as you raise money.

Ordinary shares explained: definition

Ordinary shares are the most common type of share. They are usually created, or issued, when you set up and incorporate your limited company.

Ordinary shares typically carry two rights:

• The right to vote. The holder gets a say on the decisions put to shareholders.
• The right to dividends. The right to receive a percentage, or proportion, of the profits of the limited company.

That is about it. The ordinary share is really quite ordinary. It is not very exciting or novel. Because there is no legal definition fixing what it must contain, the interesting part is how you make a class of shares more creative and bespoke to your specific needs. The three rights below are my favourites.

Why the lack of a legal definition matters

When people hear "ordinary shares" they assume there is a fixed bundle of rights that comes with the label. There is not. What an ordinary share does is whatever the company's articles of association say it does. For most small companies that means one vote and a share of the dividends, and nothing more.

The practical consequence is that you are free, within reason, to design shares around the people who will hold them. A majority owner, a minority investor and a founder raising money all want different things from their shares, and you can give each of them a class that does what they need. The three rights that follow are the ones I reach for most often.

How do drag along rights work?

Drag along rights give the holder of a share that carries them the right to drag along everyone else. What does that mean in practice?

If enough shareholders are willing to sell their shares to a third party, those willing sellers can enforce the sale and drag along everyone else in the company to sell their shares to that third party too. The minority cannot block the deal by refusing to sell.

Why use drag along rights?

You might want to consider adding drag along rights to your shares if you are the majority shareholder of your company and your plan is to exit the business in the future, for example by selling to a private equity firm.

Buyers of that kind usually want 100% of the company. Without drag along rights, a small shareholder could hold up the whole sale or demand a premium for their consent. With them, the majority can deliver the entire company to the buyer. For a fuller treatment see drag along rights explained.

How do tag along rights work?

Tag along rights are similar to drag along rights, but they work the other way round. Here is how they operate.

If enough shareholders are willing to sell to a third party, the shareholders who have not been offered the chance to sell to that third party can decide to tag along and sell their shares on the same terms as well.

This is especially interesting if you are an investor taking a minority stake in a company. You want to make sure that if there is an exit one day, you are part of it and you get to recoup your investment and more, rather than being left behind as a minority shareholder in a company now controlled by someone you never chose. See tag along rights explained for more detail.

How do anti-dilution rights work?

If you are an investor, the third right is the one you will be most interested in: anti-dilution provisions.

Anti-dilution provisions deal with what happens when the company you have invested in goes on to have more funding rounds and issues more shares to more investors. Normally, every new share issued reduces your percentage of the company. Anti-dilution provisions allow you to maintain the percentage you initially held, because they compel the company to give you more shares at no extra cost as it issues shares to others.

Here is a simple illustration. Suppose you invest and end up holding 10% of the company. The company then raises a second round and issues a large number of new shares to a new investor. Without protection, your 10% might fall to, say, 7%. With anti-dilution provisions, the company must issue you enough extra shares, free of charge, to bring you back up to 10%.

For an early investor this is a significant protection. For a founder it is a term to think carefully about before agreeing, because every free share issued to one investor dilutes everyone else, including you.

Which right suits which shareholder?

Pulling the three together:

• Majority owner planning an exit: drag along rights, so a minority cannot block the sale of the whole company.
• Minority investor: tag along rights, so you can join any sale on the same terms, and anti-dilution provisions, so later rounds do not shrink your stake.
• Founder raising money: the separate founder share class described below, so dilution does not mean losing control.

None of these are mutually exclusive. A well-drafted set of articles will often contain all of them, each attached to the class of shares held by the people they are meant to protect.

Bonus tip for founders: a separate class with exclusive voting rights

If you are a founder, here is what I like to do for my founder clients: make sure their shares are recognised as a separate class of shares.

This is where it gets interesting. That founder class is given the exclusive right to vote on specific matters. It means that even if you continue to issue more shares and raise more funds, and as a result the percentage of the company you hold goes down, you do not automatically lose control of the company. As long as you hold that class of shares, you alone can vote on those reserved matters.

In my experience this is one of the simplest ways to reconcile two things founders want at the same time: outside investment and continued control. Rather than fighting dilution, you decide in advance which decisions are yours and build that into the share class.

Next steps

Work out which of these rights matter to you. A majority owner planning an exit wants drag along rights. A minority investor wants tag along and anti-dilution protection. A founder wants a separate class with reserved voting matters. All of them have to be created properly in the articles of association in compliance with the Companies Act 2006, so speak to a corporate solicitor before issuing shares. For the mechanics, see how to create different classes of shares and classes of shares explained.