DRAG-ALONG RIGHTS AND TAG-ALONG RIGHTS

( by Andrew Baek / August 8, 2024 )

In corporate governance, the terms “drag-along rights” and “tag-along rights” are critical mechanisms designed to protect the interests of both majority and minority shareholders during buyouts. These rights provide mechanisms for either forcing the sale of shares (drag-along) or allowing minority shareholders to participate in a sale (tag-along).

Drag-along rights enable majority shareholders to compel minority shareholders to join in the sale of a company. When invoked, these rights require minority shareholders to sell their shares on the same terms and conditions as the majority shareholders. This mechanism is primarily designed to simplify the sale process and prevent minority shareholders from blocking the transaction.

Drag-along rights are typically triggered when a predetermined shareholder, usually a majority shareholders, agrees to sell its shares. All shareholders, or certain predetermined percentage of shareholders, including minority shareholders, must receive the same price per share and terms in the sale. By compelling all shareholders to participate in the sale, drag-along rights prevent holdouts.

Prospective buyers are often more interested in acquiring 100% of a company, and drag-along rights provide assurance that they can achieve full ownership without minority shareholders obstructing the deal. While ensuring the participation of all shareholders, drag-along rights also mandate that the terms of sale are fair and reasonable, protecting the financial interests of minority shareholders.

Tag-along rights give minority shareholders the right to join in a sale initiated by majority shareholders. When majority shareholders agree to sell their share, minority shareholders can “tag along” and sell their shares on the same terms and conditions. This mechanism is designed to protect minority shareholders from being left behind or disadvantaged when major sales occur.

Unlike drag-along rights, which compel minority shareholders to sell, tag-along rights provide them with the option to participate in the sale. Minority shareholders who exercise their tag-along rights are entitled to sell their shares at the same price and on the same terms as the majority shareholders. Tag-along rights ensure that minority shareholders are not left out of lucrative deals.

These tag-along rights are crucial for protecting minority shareholders from being marginalized in significant transactions, ensuring they receive equal financial opportunities. Minority shareholders with tag-along rights can negotiate better terms, knowing they have the option to join any sale initiated by majority shareholders.

While both drag-along and tag-along rights aim to protect shareholders and ensure fair transactions, they serve different purposes and provide different levels of control and protection:

Drag-along rights primarily grant control to majority shareholders to ensure smooth transactions and full ownership transfer, while tag-along rights provide protection to minority shareholders, ensuring they can benefit from sales initiated by majority shareholders. Drag-along rights compel minority shareholders to sell their shares under specified conditions, and tag-along rights offer minority shareholders the option to sell their shares but do not compel them. Both rights ensure that all participating shareholders receive the same terms and price per share, promoting fairness in transactions.

Incorporating drag-along and tag-along rights into shareholders’ agreements requires careful legal drafting to balance the interests of majority and minority shareholders. It is crucial to clearly define the conditions under which these rights can be exercised, ensure the terms of sale are fair and transparent, and adhere to local corporate laws and regulations to avoid disputes and ensure enforceability.

Drag-along and tag-along rights are essential tools in corporate governance, particularly in private equity and venture capital. They facilitate fair and efficient transactions by balancing the interests of majority and minority shareholders. Properly implemented, these rights can enhance shareholder cooperation and contribute to smoother corporate transactions.

If you need to incorporate drag-along or tag-along rights in your contracts or need advice on how to modify the terms to your advantage, feel free to contact us via email at inpyeong@inpyeonglaw.com or by phone at +82 2038 2339.

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