Tag-Along Rights: A Concise Guide for Shareholders and Investors

What are tag-along rights?

Tag-along rights (also called co-sale rights) are contractual protections for minority shareholders. They allow minority holders to join a sale initiated by a majority shareholder and sell their shares on the same terms and price. These rights are common in venture capital, private equity, and startup shareholder agreements to preserve liquidity and fairness for smaller investors.

How tag-along rights work

• Trigger: A majority shareholder negotiates a sale of some or all of their shares to a third-party buyer.
• Effect: Minority shareholders with tag-along rights can require that the buyer also purchase their shares on the same price and terms (pro rata or up to a specified amount).
• Purpose: Prevents minority holders from being left behind with a less-liquid or devalued stake and ensures they benefit from the terms the majority negotiated.

Practical example

Three co-founders retain minority stakes after a large angel investor acquires 60% of the company. Years later the investor finds a buyer willing to pay $30 per share for the 60% stake. Because the co-founders negotiated tag-along rights, they can sell their shares at the same $30 price under the same terms.

Benefits and drawbacks

Pros:
* Protects minority shareholders from being excluded from lucrative exit opportunities.
* Provides liquidity in otherwise illiquid private-company shares.
* Encourages fair pricing because minority holders share in negotiated terms.

Cons:
* Can complicate or slow down major shareholders’ sales, potentially making the company less attractive to some investors.
* May limit flexibility for majority holders who must accommodate additional sellers.
* Enforcement and mechanics (timing, pro rata allocation) can become contentious if not clearly defined.

Tag-along vs. drag-along rights

• Tag-along rights: Protect minority shareholders by letting them join a sale initiated by the majority.
• Drag-along rights: Protect majority shareholders by allowing them to compel minority holders to sell when a buyer requires 100% (or a critical mass) of the company’s shares.

Key negotiation elements

For tag-along rights:
* Scope: Does the right apply to all sales or only certain types (e.g., strategic buyers, change-of-control)?
* Quantity: Can minority shareholders sell all of their shares or only a proportional amount?
* Notice and timing: How much advance notice must be given and within what window can tag-along rights be exercised?
* Mechanics: How are transfers executed, and what role do intermediaries or the buyer play?
* Price and terms: Clarify whether minority sellers must accept exactly the same consideration (cash vs stock) or if adjustments are permitted.

For drag-along rights:
* Threshold: What percentage of shares held by the majority triggers the drag (commonly 75%, but variable)?
* Consideration: What forms of consideration are acceptable (cash, stock, mixed)?
* Preemption and protections: Do minority shareholders have any rights to preemptive purchase or appraisal if forced to sell?
* Notice and process: Define timelines and steps for compelling the sale and transferring shares.

Related shareholder protections

• Preemptive rights: Allow existing shareholders to buy newly issued shares before outsiders to avoid dilution.
• Appraisal rights: Permit shareholders to demand a court-determined fair value for their shares if they dissent from certain corporate actions (e.g., mergers).
• Information rights: Give shareholders access to financials, board minutes, and other disclosures to monitor performance and evaluate sale offers.

Practical tips

• Draft clear, specific language about triggers, scope, timing, and mechanics to reduce disputes.
• Balance protections: minority holders should seek meaningful tag-along provisions, while majority holders may negotiate limits (e.g., thresholds, caps).
• Consider marketability: overly broad tag-along rights can deter strategic buyers or investors; tailor provisions to the company’s stage and investor base.
• Coordinate with other rights: Align tag-along terms with drag-along, preemptive, and appraisal provisions for consistency.

Key takeaways

• Tag-along rights protect minority shareholders by enabling participation in sales on the same terms negotiated by majority holders.
• Drag-along rights serve the opposite purpose: enabling majority holders to compel minority sales to complete a full-company transaction.
• Well-drafted tag-along and drag-along clauses, coordinated with preemptive and appraisal rights, help balance interests, enhance fairness, and improve exit clarity for all parties.