Drag-along vs. tag-along rights

Drag-along and tag-along rights are two sides of the same coin. They are both legal safeguards that benefit different shareholder groups. 

Majority shareholders get the right to “drag along” smaller shareholders when negotiating a deal. And minority shareholders get the right to “tag along”, or piggyback and benefit from the conditions negotiated by the bigger player. 

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Who benefits from drag-along rights?

Drag-along rights protect majority shareholders. Let's say a shareholder with a 70% stake in a company finds a buyer. The buyer wants to buy 100% of the company. Drag-along rights mean the majority shareholder can force minority shareholders to sell. 

This means:

• The majority shareholder can exit when they want, assuming they’re able to negotiate a sale. 
• Minority shareholders can't block a sale and may be forced to exit their positions, even if they don't want to.
• Drag-along rights make the company more attractive to potential buyers who might want 100% control. 

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Who benefits from tag-along rights?

Tag-along rights protect minority shareholders. If the majority shareholder sells, tag-along rights mean the buyer must offer the same deal to minority shareholders. 

That means:

• Minority shareholders don't get left behind. They avoid being stuck with shares in a company under new ownership and, potentially, a new direction.
• They benefit from the negotiating power of the majority shareholder and don't have to accept a subpar deal.
• However, potential buyers may not want to acquire the minority stake, so tag-along clauses can make the company less attractive.

Drag-along and tag-along rights can affect all types of investors. But they have a particularly pronounced impact on private equity investors. 

Private companies have fewer governance rules and are more likely to be sold than established, listed companies. These protections come into play when a venture gets acquired.

A Yale study shows a dramatic increase in the number of venture-capital-backed startups that were acquired, rather than going public with an IPO. The percentage has jumped from 10% to 90% in the past three decades.

The biggest takeaway for startup shareholders and private investors is that you need to know what is in the shareholders' agreement. 

As a minority shareholder, you're unlikely to be able to stop a buyout from happening. But you can make sure your interests are protected if a sale takes place. Pay attention to what would trigger a drag-along and what timeline the process would follow. This guide to startup equity management covers other key agreement clauses to review — especially if long-term liquidity is a goal.

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Augment simplifies legal complexity in private markets

The growth of private stock marketplaces like Augment has helped to make startup investing more accessible. No longer are pre-IPO companies the sole purview of venture capital and private equity firms. Now, accredited investors can connect directly with shareholders of early-stage companies on private secondary market platforms. 

Augment offers features that are transparent and gives accredited investors accessible price information and other tools to simplify due diligence. Augment is a compliant marketplace that gives a structure to each transaction. Sales usually need to be approved by the company and will likely follow the existing shareholders' agreement. SPVs play a central role in many secondary deals, and this breakdown of their structure explains how shareholder rights — including drag-along and tag-along clauses — apply when shares are pooled.

If you're considering trading on a private secondary marketplace like Augment, be sure to fully understand your rights, including what will happen if there's an acquisition. The specifics of any drag-along and tag-along rules could force you to sell. They may also mean you get a better price than if you tried to negotiate alone.