Stuck in the mud? Know your drag and tag notice rights as a founder

Posted Wednesday 18th September 2024

If a majority shareholder (commonly greater than 50% of a company) receives an offer from a third party for their shares in the company, a drag notice (if triggered) will force the minority shareholders of the company to sell their shares on the same terms as the majority shareholder, so that the purchaser can buy the entire share capital of the company.

Alternatively, a tag notice (if triggered) will allow minority shareholders to sell their shares to a third party if they wish to, receiving the same offer (i.e. price per share) for their shares.

In this article, we will go into further detail on drag and tag along notices and why it is important for founders to understand their obligations and rights in relation to these provisions.

Drag along notices.

Content of the notices

A drag along notice serves to protect the majority shareholder’s interests, stopping any minority shareholders from holding up a deal going through.

A drag along provision would be found in a company’s articles of association (Articles) and outlines the conditions required for a drag along to be triggered, such as:

How many shares are required to be transferred and to whom.
Which classes of share are to be transferred.
The price per share.

Things to consider

When deciding whether to implement drag along provisions into your Articles, or negotiating their contents, there are key balances to be aware of:

The presence of drag notices is often welcomed by prospective buyers, who are looking to acquire the whole share capital of the company. This is because it streamlines a sale process.
However, if the drag along threshold is set too low, this may not be in the interest of certain shareholders, such as VC investors, who often purchase minority shareholdings and would not want to have their holding liquidated on timescales they had not chosen.

Tag along provisions

Content of the notices

Tag along provisions are also found in a Company’s Articles, and serve to protect a minority shareholders’ interests.

Tag along provisions commonly outline:

The process minority shareholders would go through to serve their tag along notice, such as how long before the proposed sale they must serve the notice, and the number and class of shares to be purchased.
The parameters of the notice, such as enforcement and execution mechanisms, including that the proposed sale will not be able to complete if tag notices are not adhered to.

Things to consider

It is important for founders to bear in mind that minority shareholders typically have little bargaining power over the terms of the sale of the entire issued share capital of a company, so typically would be beholden to the terms agreed between majority shareholders and the third party purchaser.

By incorporating a fair tag along provision from a company’s perspective, it reduces the chance of being sued by minority shareholders for unfair treatment in the event of a sale to a third party, and can also attract new investment from prospective minority shareholders through offering more liquidity options.

Conclusions

Drag and tag notices offer a chance for founders to shift the balance between minority shareholders and prospective purchasers, through either allowing the minority shareholders to require the third party purchasers to buy out their shareholding (as a result of tag notices) or requiring minority shareholders to sell their shareholding (as a result of drag notices).

Balancing these interests can be challenging, especially when there is the need to establish them before the actual sale event presents itself. Therefore, reach out to Rajiv Samani of our Corporate team, to make the most of their extensive experience in this area!

This article is for reference purposes only. It does not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking or deciding not to take any action.