What are Drag Along and Tag Along Provisions in a Shareholders Agreement?

A shareholders agreement is a legally binding contract between shareholders and a company, as well as between each shareholder. The drag along and tag along provisions are an example of a balancing act between the rights of a majority shareholder and a minority shareholder. This article will explain what a shareholders agreement is and what drag along and tag along provisions are.

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What is a Shareholders Agreement?

A shareholders agreement governs the shareholders, their business relationships and arrangements. It also sets out the shareholders:

• rights;
• responsibilities;
• liabilities; and
• obligations.

A shareholders agreement will typically contain several provisions to ensure equal treatment amongst shareholders.

Why Do I Need A Shareholders Agreement?

If you are a privately held company with multiple shareholders, a shareholders agreement will define the rules and expectations governing the relationship between shareholders and the company’s operation. A well-drafted shareholders agreement is essential for preventing conflicts, protecting the interests of all shareholders, and providing a framework for the smooth operation and management of the company. 

For instance, a shareholders agreement often sets out the process for resolving disputes among shareholders, including mediation or arbitration clauses. Having shareholders agree to these procedures will protect the company from engaging in costly litigation.

What is a Drag Along Provision?

A drag along provision allows the majority shareholder(s) to require the minority shareholder(s) to sell their shares. This is usually triggered in a takeover offer.

For example, a bidder would like to buy the entire company. The majority shareholder(s) holding more than 50% of the company agree to sell their shares. Therefore, in this situation, the majority shareholder(s) can “drag along” the remaining minority shareholder(s) and require them to sell their shares. Accordingly, the bidder can purchase the entire company.

What is a Tag Along Provision?

A tag along provision has the opposite effect of a drag along provision. In a well-drafted and well-balanced shareholders agreement, when a shareholder wishes to sell their shares, they usually have to provide notice to the other shareholders. This requirement is usually contained within a first right of refusal clause.

However, the majority shareholder(s) may want to sell shares to a third party, and they do not notify the other shareholders. Here, the tag along provision will enable the minority shareholder(s) to tag along with the majority shareholder(s) and sell their shares for the same price and on the same terms and conditions.

Other Common Clauses

There are other common clauses that you can expect to see in a shareholders’ agreement.

First is a clause specifying how the ownership and equity of the company are distributed among the shareholders. It may outline the number of shares each shareholder holds and any restrictions on transferring or selling them. 

Shareholders’ agreements will typically define how the company will be managed and decision-making protocols. This may include provisions for:

• appointing directors;
• electing officers; and 
• making important business decisions.

Another common clause relates to the exit strategy. This clause may outline the strategy for selling the company, including conditions under which a sale can occur and the distribution of proceeds among shareholders.

Key Takeaways

Drag along and tag along provisions are important clauses in any shareholders’ agreement. A drag along provision allows a majority shareholder to make a minority shareholder sell their shares. In contrast, a tag along provision allows minority shareholders to sell their shares for the same price, on the same terms and conditions as the majority shareholder, if the majority shareholder:

• is selling to a third party; and
• has not notified the other shareholders.

If you need help drafting a shareholders agreement or understanding your drag along and tag along provisions, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page. 

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