# Understanding Tag-Along vs. Drag-Along Rights in Business Deals

![Tag-Along Rights](https://www.investopedia.com/thmb/U9aJLFBkaMTrQt4IcTQC5y7fzB4=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/tagalongrights.asp-final-06372575a74e449a90461f433023d296.jpg)

*— Investopedia / Jake Shi*

> **Definition**
>
> Tag-along rights are contractual obligations used to protect a minority shareholder.

Tag-along rights, or co-sale rights, serve as a legal safeguard for minority shareholders by allowing them to participate in sales initiated by majority stakeholders, ensuring they can sell their shares under the same conditions. Conversely, drag-along rights enable majority shareholders to compel minority stakeholders to sell their shares, facilitating full company buyouts. These mechanisms are essential in venture capital and private equity transactions, balancing the interests of all shareholders.  

### Key Takeaways

*   Tag-along rights allow minority shareholders to sell their shares on the same terms as majority shareholders, offering protection in a sale.  
    
*   Drag-along rights enable majority shareholders to compel minority shareholders to sell their shares, ensuring simplicity in full company sales.  
    
*   Tag-along and drag-along rights aim to balance power between majority and minority shareholders, impacting liquidity and negotiation dynamics.  
    
*   While tag-along rights provide minority shareholders with liquidity and fair pricing, they may deter some majority investors due to their constraints.

## What Are Tag-Along Rights and How Do They Work?

Tag-along rights let minority shareholders sell their shares if a majority shareholder is selling theirs. These rights are common in startups and private firms, offering upside potential.

Tag-along rights give minority shareholders the ability to capitalize on a deal that a larger shareholder—often a financial institution with substantial pull—puts together. Large shareholders, such as [venture capital](https://www.investopedia.com/terms/v/venturecapital.asp) firms, are usually more able to find buyers and negotiate payment terms. Tag-along rights, therefore, offer minority shareholders greater [liquidity](https://www.investopedia.com/terms/l/liquidity.asp). Private equity shares are hard to sell, but majority shareholders can often ease purchases and sales on the [secondary market](https://www.investopedia.com/terms/s/secondarymarket.asp).

> **Important**
>
> Under most states' laws for corporations, majority shareholders owe a fiduciary duty to minority shareholders, meaning they must deal with minority shareholders honestly and in good faith.

## Pros and Cons of Tag-Along Rights

Tag-along rights provide minority shareholders, including stock-owning employees, with financial and legal protection during a company sale. During a sale, minority shareholders often lack the bargaining power to negotiate better deals. Tag-along rights benefit minority shareholders because they're able to receive the same benefits the majority shareholders bargain for.

However, tag-along rights may deter majority shareholders from investing, as they require large shareholders to make concessions benefiting only minority shareholders. In other words, some investors will simply not select a company that makes less-than-favorable obligations of them.

## Examples of Tag-Along Rights

Co-founders, [angel investors](https://www.investopedia.com/terms/a/angelinvestor.asp), and venture capital firms often rely on tag-along rights. For example, suppose three co-founders launch a tech company. The business is going well, and the co-founders believe they have proved the concept enough to scale. The co-founders then seek outside investment in a seed round. A private equity angel investor sees the company's value and offers to buy 60% of it, requiring a large amount of equity to compensate for the risk of investing in the small company. The co-founders accept the investment, making the angel investor the largest shareholder.

The investor is tech-focused and has significant relationships with some of the larger public technology companies. The startup co-founders know this, so they negotiate tag-along rights in their investment agreement. The business grows consistently over the next three years, and the angel investor, happy with the [investment returns](https://www.investopedia.com/terms/r/returnoninvestment.asp), looks for a buyer of their equity among the major tech companies.

The investor finds a buyer who wants to buy the entire 60% stake for $30 a share. The tag-along rights negotiated by the three co-founders give them the ability to include their equity shares in the sale. The minority investors are entitled to the same price and terms as the majority investor. Thus, using their rights, the three co-founders effectively sell their shares for $30 each.

## Comparing Tag-Along Rights and Drag-Along Rights

Tag-along, or co-sale rights, are the opposite of [drag-along rights](https://www.investopedia.com/terms/d/dragalongrights.asp). The major difference is that the former enables and protects minority shareholders, while the latter enables and protects majority shareholders. Tag-along rights allow minority shareholders to participate in a sale initiated by the majority shareholder, permitting them to sell their shares at the same price and terms and preventing them from being left behind or forced to sell at a lower price.

Drag-along rights favor majority shareholders, allowing them to force minority shareholders to sell their shares when the former sell theirs. This is a way to ensure the majority shareholder can deliver 100% of the company's shares to a buyer.  

Tag-Along Rights

*   Purpose: Protect minority shareholders
    
*   Effect: Minority shareholders can sell at same price and terms
    
*   Trigger: Majority shareholder decides to sell
    
*   Impact: Ensures minority shareholders can participate in sale and receive a fair price
    
*   Negotiation points: Sale of all or part shares, notice and timing, execution and enforcement
    

Drag-Along Rights

*   Purpose: Enable majority shareholder to force minority shareholders to sell
    
*   Effect: Minority shareholders are forced to sell at same price and terms
    
*   Trigger: Majority shareholder decides to sell and critical mass of shareholders wish to sell
    
*   Impact: Ensures majority shareholder can deliver 100% of share capital to buyer
    
*   Negotiation points: Threshold percentage, preemption rights, consideration, notice periods
    

### Key Considerations in Negotiating Tag-Along Rights

The terms when negotiating tag-along rights and drag-along rights are quite different. When negotiating tag-along rights, there are a few key considerations:

*   **Selling all or part of the shares**: You must determine whether the tag-along right applies to selling all shares held by the minority shareholder or only a portion of those shares.
*   **Notice and timing**: A tag-along negotiation will need to establish the notice period and timing for exercising the tag-along right so that minority shareholders have enough time to prepare for the sale and negotiate the terms of the sale.
*   **Execution and enforcement mechanism**: You'll need to determine the procedures for executing the sale and enforcing the terms of the sale. This includes details on the role of the majority shareholder, the buyer, and any intermediaries in the transaction.

### Essential Tips for Negotiating Drag-Along Rights

These are the negotiating points for these rights:

*   **Threshold percentage of shares**: It's important to determine the percentage of shares that triggers the drag-along right because it ensures that the majority shareholder can force the minority shareholders to sell their shares when a critical mass of shares is involved. This threshold is usually around 75%, but it can be lower depending on the structure and bargaining power of the parties.
*   **Preemption rights**: For a drag-along right negotiation, whether the minority shareholders have preemption rights to buy the shares being sold by the majority shareholder should be established as it affects the minority shareholders' ability to participate in the sale and ensure they receive a fair price for their shares.
*   **Consideration offered**: The type of consideration offered by the buyer should also be determined. This includes cash, stock, or other compensation. The type of consideration shows the minority shareholders' willingness to participate in the sale and ensures they receive a fair price for their shares.  
    

## How Are Drag-Along or Tag-Along Rights Different From Preemptive Rights?

While drag-along and tag-along rights focus on the sale of shares, preemptive rights are designed to protect shareholders from dilution. Preemptive rights give existing shareholders the chance to buy more shares before the company offers them to new investors, so they can keep the same ownership percentage.

## How Do Appraisal Rights Affect Minority Shareholders?

Appraisal rights allow minority shareholders to demand a fair valuation and compensation for their shares if they disagree with certain corporate actions, such as mergers or consolidations. These rights offer a form of protection, ensuring that minority shareholders receive equitable treatment and are not forced to accept unfavorable terms.

## What Are Shareholder Information Rights?

Information rights entitle [shareholders](https://www.investopedia.com/investing/know-your-shareholder-rights/) to access essential company information, such as financial statements, annual reports, and board meeting minutes. These rights improve transparency and allow shareholders to make informed decisions about their investments, check on company performance, and hold management accountable for their actions.

## The Bottom Line

Tag-along and drag-along rights are crucial tools in shareholder agreements that ensure fair and balanced transactions between majority and minority shareholders. Tag-along rights empower minority shareholders by allowing them to participate in a sale at the same terms when a majority shareholder decides to sell. Conversely, drag-along rights facilitate smoother transactions by enabling majority shareholders to require minority shareholders to sell their shares, offering potential buyers a path to full ownership. Both mechanisms help align shareholder interests, enhance transaction liquidity, and promote equitable treatment, ultimately making companies more appealing to investors.

> **Article Sources**
>
> 1.  Rocket Lawyer. "[Drag Along and Tag Along Rights](https://www.rocketlawyer.com/gb/en/business/run-a-private-limited-company/legal-guide/drag-along-and-tag-along-rights)."
>     
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>     
> 3.  Keith A. Allman. "[Impact Investment: A Practical Guide to Investment Process and Social Impact Analysis](https://www.wiley.com/en-jp/Impact+Investment:+A+Practical+Guide+to+Investment+Process+and+Social+Impact+Analysis,+++Website-p-9781118848647)," Pages 191-194. John Wiley & Sons, 2015.
>     
> 4.  Mahendra Ramsinghani. "[The Business of Venture Capital: Insights from Leading Practitioners on the Art of Raising a Fund, Deal Structuring, Value Creation, and Exit Strategies](https://www.wiley.com/en-us/The+Business+of+Venture+Capital%3A+The+Art+of+Raising+a+Fund%2C+Structuring+Investments%2C+Portfolio+Management%2C+and+Exits%2C+3rd+Edition-p-00048141)," Pages 279. John Wiley & Sons, 2014.
>     
> 5.  Jay E. Fishman, Shannon Pratt, and William J. Morrison. "[Standards of Value: Theory and Applications](https://www.wiley.com/en-hk/Standards+of+Value:+Theory+and+Applications,+2nd+Edition-p-9781118138533)," Pages 99-102. John Wiley & Sons, 2013.