Drag-Along and Tag-Along Rights: what are they, why are they necessary and how do they affect the valuation of a minority shareholding?
The valuation of shares in a company can be complex and even more complicated when valuing a minority shareholding. I was recently instructed by the solicitors acting for the wife in a divorce, not to prepare a formal valuation of the husband’s minority shareholding, but to provide an opinion as to whether the valuation provided by the husband’s accountants was ‘broadly correct and appropriate’. On this occasion there was a shareholders’ agreement which provided detail regarding the shareholders’ rights, obligations and liabilities including a ‘Drag-Along and Tag-Along ‘clause. The husband’s accountants had not considered the relevance of this clause. After detailed consideration, I concluded that the husband’s accountants had significantly undervalued the husband’s minority shareholding.
What are Drag-Along Rights?
A drag-along is a provision in a shareholders’ agreement that enables the majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller.
Why are Drag-Along Rights necessary?
They provide liquidity, flexibility and an easy exit route for a majority shareholder. Many buyers of a target company will want 100% control over a business and rarely agree to allow a minority shareholder to retain a minority share. Without them, it would be difficult for a majority shareholder to accept an offer if the minority shareholders were uncooperative and blocked the sale of the company.
How do Drag-Along Rights affect the valuation of a minority shareholding?
Minority shareholders may be able to insist on a minimum price level in order to avoid having to sell at an undervalue and want a mechanism in place to verify that the price offered for the shares has been fairly valued and is above the minimum price level.
What are Tag-Along Rights?
A Tag-Along is a provision in a shareholders’ agreement that offers the minority shareholders the option to sell but, unlike the drag-along clause, it does not mandate an obligation.
Why are Tag-Along Rights necessary?
They provide protection to minority shareholders from being left behind when a majority shareholder decides to sell their shares. If a minority shareholder held 10% of the shares in a company, it would be difficult to sell, as most buyers will want 100% of the company and not 10%. This puts minority shareholders at risk of being forced to sell their shares at a price which is substantially much lower or has no relationship to the actual value of the company. Without tag-along rights, shareholders may find that they hold unsaleable or devalued shares.
How do Tag-Along Rights affect the valuation of a minority shareholding?
In delivering a larger controlling stake to the prospective purchaser, such tag-along rights may potentially secure a higher share valuation for a minority shareholding.