Shareholder Agreements are vital for safeguarding shareholders’ interests during mergers and acquisitions and business exits.
In this article, we’ll explain what some of the more confusing terms mean, breaking down the meaning of Drag-Along, Tag-Along, and Pre-emptive Rights.
These are three really important provisions in Shareholder Agreements that protect shareholder interests when planning for an exit.
Drag-Along Rights
If a majority shareholder is selling their shares to a third party, Drag-Along Rights allow them to compel minority shareholders to sell their shares in a company. This helps facilitate a smoother M&A process and prevents disputes.
For example, if a majority shareholder decides to sell their shares to a third party, the Drag-Along Rights provision in the Shareholder Agreement can be triggered, requiring the minority shareholders to sell their shares as well. This ensures that the sale of the company is not blocked by minority shareholders who may have different interests.
SMEs should include Drag-Along Rights in their Shareholder Agreements to ensure that the transaction includes all shareholders (avoiding any disagreements when an exit opportunity presents itself).
Tag-Along Rights
If a majority shareholder is selling their shares to a third party, Tag-Along Rights give minority shareholders the right to sell their shares along with the majority shareholder. This provision safeguards minority shareholders from being excluded from the transaction. To ensure that minority shareholders are treated fairly during a business exit, SMEs should ensure they include Tag-Along Rights in their Shareholder Agreements.
Considering that a majority shareholder is selling their shares to a third party, the Tag-Along Rights provision in the Shareholder Agreement can be triggered, allowing the minority shareholders to sell their shares as well. This ensures that the minority shareholders are not left out of the sale and can also benefit from the transaction.
Pre-emptive Rights
Pre-emptive Rights, also known as right of first refusal, allow existing shareholders to purchase newly issued shares of a company before they are offered to the public or other investors. This helps maintain control over the company’s ownership structure and prevents dilution of ownership interests. SMEs should include Pre-emptive Rights in their Shareholder Agreements to safeguard their investment.
In essence, if a company decides to issue new shares, existing shareholders must be offered the opportunity to purchase them before they are offered to the public or other investors.
Shotgun Clause
Also known as a buy-sell provision or an auction provision, it is a type of dispute resolution clause that may be included in Shareholder Agreement. In essence, it allows one shareholder to make an offer to buy out the other shareholder(s) at a fair price, which the other shareholder(s) must either accept or match in order to buy out the initiating shareholder.
If the partners can’t agree on something big – like the future direction of the company, they can turn to the shotgun clause to settle the dispute.
One partner can “shotgun” an offer to the other to buy their share of the business at a certain price. The other partner can then choose to buy them out at that price…. or offer to buy the first partner’s share for the same price. They go back and forth until they finally agree on a price. It’s like a game of “you buy me out, or I buy you out” with strict rules.
[Check our article dedicated to this clause here]
To safeguard all shareholders’ interests during a business exit, including Drag-Along, Tag-Along, and Pre-emptive Rights in Shareholder Agreements is essential. SMEs should seek professional advice when drafting their Shareholder Agreements to ensure that these provisions are included. As commercial lawyers with expertise in M&A, we recommend that SMEs and their advisors consider the importance of Shareholder Agreements and these critical provisions when planning for a business exit.
We have included something that we think might be the most helpful and relevant for business owners to get started or polish up their skills:
The Deal Room podcast Episode 240 – Business Sale or Share Sale: Which best fits your position? Tune in today!
If you are after some helpful resources – here’s our most popular picks for business owners upskilling on the knowledge front.
📖Buy Grow Exit (lucky you – click here for a bonus 20% OFF before 31st March 2023)
🎙️The Deal Room Podcast – be sure to subscribe to hear the latest tips, tricks and traps from buyers, sellers and business brokers.
