Drag along rights enable a majority shareholder to force a minority shareholder to join in the sale of a company. They are designed to protect the majority shareholder and are often seen on private equity deals to enable the investor to sell a portfolio company and realise its investment.
A buyer will rarely be content purchasing anything less than the entire share capital of a target company and will want complete control. Drag along rights help to eliminate minority shareholders and allow a buyer to purchase 100% of the shares.
The rights are often put in place during investment negotiations between a company’s majority and minority shareholders and may be included in a target company’s articles of association as a way of pushing through a sale more quickly and on terms more appealing to the buyer. So majority shareholders can benefit from drag along rights, but what about minority shareholders who are effectively ‘dragged in’ to a deal? Well they can also benefit. For drag along rights to be triggered and applied effectively, they require the price and the terms and conditions relevant to the deal to be consistent. So interested parties who may only hold a small percentage of the shares can realise better terms than might be expected for a shareholding with little or no influence over corporate matters.
Drag along in private equity
A private equity investor will want to realise its investment in a portfolio company within a few years so that it can return the sale proceeds (hopefully with a healthy profit) to its own investors. An exit might be achieved via an IPO, a trade sale or a secondary buy-out (a sale to another, bigger investor). In each case, drag along rights can help secure that important exit for the investor.
An exit would be easy if all the shareholders were willing to sell their shares in the target company. But if one or more of the other shareholders is reluctant to sell (perhaps because they believe the company’s performance and value will increase in the future, or they are emotionally invested in the company and don’t want to leave any potential success behind), this can cause a problem. Including drag along rights in the shareholder documentation from the start ensures that a reluctant minority cannot prevent a sale by a willing majority.
Typical drag along provisions will empower the shareholder who wants to sell (and has found a buyer) to ‘drag’ and force the other shareholders to sell to the buyer on the same conditions and terms. So a private equity fund holding the drag along rights is able to exit the company and deliver 100% of the shares to the buyer.