Drag-Along Rights vs. Tag-Along Rights

The Boulder Startup Lawyers  of LaszloLaw Discuss Drag-Along Rights and Tag-Along Rights in an Operating or Shareholder Agreement.

Boulder Startup Lawyer | Boulder Startup AttorneyOperating agreements and shareholder agreements typically include provisions that control in the event that an interest in a company is being sold to a third party. One such provision might be a Right of First Refusal–this is where if say one LLC member wants to sell his/her interest in the company, the other company owner(s) may have the first right to purchase the selling member’s interest at fair market value or possibly some other pre-determined method of valuation.

Drag-Along Rights

Other provisions that can often be included in an operating agreement or shareholder agreement are Drag-Along Rights and Tag-Along Rights provisions. Put simply, Drag-Along Rights protect majority interests whereas Tag-Along Rights protect minority interests.

Drag-Along Rights provisions control where a majority interest of owners desire to sell their interests, they can drag along the minority owners, forcing them to sell.  For instance, say an LLC has three owners. Two owners represent a 75% interest whereas the third owns 25%.  If the two owners with 75% interest wish to sell their interest to a third party, they can force the 25% owner to also sell his/her interest under the same terms/amount as their sale to the third party under a Drag-Along provision.  This provision is often included to prevent a minority interest holding out and holding a deal hostage.

Tag-Along Rights

Tag-Along Rights protect the minority owner. Take the same scenario above where there are three LLC owners–two with 75% interest and one with 25%. If the two owners with 75% interest want to sell their interests, a prospective buyer might not be concerned or even want to buy the remaining 25% since they will have 75% interest and control of the company. This leaves the 25% interest owner in a position wherein their interest might now be devalued or they own 25% interest in a company that is now controlled by a third party. The 25% minority owner never bargained to be in business with the third party that is now controlling the company. This is where the Tag-Along provision would kick in.  The Tag-Along provision will require the third party to offer to purchase the 25% interest of the minority owner on the same terms/amount as the 75% interests.  If the third party purchases the 75% interest without offering purchase of the 25% interest held by the minority owner, then the sale will be in breach of the operating agreement and often void under the Tag-Along clause.

Boulder Startup Lawyers

The Boulder Startup Lawyers of LaszloLaw represent and counsel businesses on a wide range of legal needs, including business formation, risk management, contract, and litigation issues. Contact our Boulder Startup Lawyers today at 303-926-0410 or online.