Tag Along: Everything you need to know
Tag-Along rights, commonly known as "co-sale rights" or the piggyback clause, are in place to protect the minority shareholders in a company. Often companies sell with the majority stakeholder selling their share through a transaction; this is when Tag Along rights come in. These rights allow the minority investor to also hop onto the negotiation train and sell their shares as well if needed.
Effectively, the majority shareholder is obliged to include the interests of the minority shareholder due to the contractual obligations, which are co-sale rights. This is a common scenario seen in a venture capital deal, especially in startups and other companies.
Minority investors can protect themselves with the help of Tag Along with rights. They will ensure that the price and terms delivered to the majority holder are the same as for the minority. The basic idea of these rights is to provide greater liquidity to minority holders.
- Why is Tag Along rights required?
- Benefits of Tag-Along
- Reasons for not using Tag Along
- Common mistakes in understanding Tag Along
- Exceptions from Tag Along
Why is Tag Along rights required?
Co-sale rights are exactly as the term suggests. The minority investors can tag along with the majority shareholders to protect their interests. In a situation where stakeholders wish to sell their shares in the company, they would offer those shares to the other shareholders. If you want to further understand how Tag-along rights can be structured, this article can be helpful.
More control for shareholders
Given, the other shareholders exercise their first right to refusal; both can exist on a fair plane. What makes the situation further fair is that minority holders can exercise their co-sale right, as mentioned in the Article of Association. Minority shareholders are restricted in selling their shares to other shareholders. Tag-Along is a helpful clause that allows them to join the majority shareholders.
Encouraging for investors
Tag-Along right is usually a pre-negotiated clause and is added to the agreement. It is common when a company works in a high risk-bearing sector where results expected are high. The presence of Tag Along is also an encouragement for investors to buy a company's stock.
Attracts better investors
Angel Investors are known to fund a startup for a part of their equity, given Tag Along is present in the agreement. In simple terms, in a situation where investor A wishes to sell their shares, B can also do so by exercising Tag Along. This would get B the same price and terms as A, ensuring balance and fair play.
Benefits of Tag-Along
These rights offer legal and financial protection to investors who might not have the resources. This helps them negotiate a better deal for their shares with the majority shareholder. There are ideally two benefits that Tag Along rights bring with them:
Control over decisions
Minority shareholders will otherwise not have as much control over a company's sale as compared to a majority shareholder. They can't sell their shares to other holders, but their rights can obligate the majority holders to turn over control to them. Technically, they have a say in the situation provided by the control Tag Along offers.
Protection of rights
When a company is being sold, owners can just sell their stake and leave the minority shareholders on their own. This will happen when co-sale is not present. In a reverse scenario, owners will be obligated to sell their stake as well as that of the minority. This means the minority will not be left with selling their stake at bad prices.
Fair play
Often owners or majority holders will have resources in terms of legal knowledge and the means to exercise it. This will allow them to initiate a better sale transaction which will most likely not happen with minority investors. Hence, using a piggyback clause becomes fair for either party.
Reasons for not using Tag Along
Co-sale rights are one of the best deals for minority investors. Things become even for them, but it is not the best scenario for majority holders. Sometimes, it can even become a difficult situation for the minority shareholders.
Difficulty in Liquidation
Most investors are looking to buy a certain number of shares or are willing to invest only a certain amount. Now, this amount will be distributed over X + the minority shares as well. Liquidation will become rather difficult, along with bargaining for the price.
This can be better explained by an example. Say, company A is being bought by investor B, who is offering a certain price for X number of shares. When the investor is informed that he/she has to buy additional shares, which would be the minority shares, he might waive the price.
Uncertainty in the company
When the minority holders sell their shares to the majority under Tag Along, a major part of the company will be possessed by them. This could cause a lot of issues given only a certain number of shareholders have a major part of ownership. Decisions could be affected, especially when a company is going under sale.
Common mistakes in understanding Tag Along
Often terms are misunderstood when it comes to defining what minority is and what majority is. These common mistakes have been found when it comes to exercising Tag Along rights.
Unclear definitions
Most important of all is defining what percentage of the ownership is declared to be the majority and how much remaining will be the minority. Most of the time, 51% ownership is called majority, but whatever it must be, the definition of it should be present in the contract.
Not defined parties
The agreement should also clearly mention which types of shares will have Tag Along rights. All shareholders don't need to have these rights, and the difference must be specified in the agreement itself.
Not showing interest
When the situation arises where Tag Along rights are available, a notice of sale is sent to applicable holders. Interested shareholders must respond to the notice to be a part of the sale. No response will be considered as no interest.
Exceptions from Tag Along
There are always exceptions to any clause. The key shareholder can, in such a situation, request a certain number of his/her shares to be exempted from the co-sale clause. This will further allow him/her to sell that portion of shares to a willing buyer.
In a way, it would be a rewarding situation for the key shareholder, which can keep them motivated towards the progress of the company. You can find a few samples of a Tag-Along clause here to understand them better.
The Piggyback clause can be a beneficial aspect for both parties if used wisely. There are different ways to even structure the clause, which could result in the majority and minority both ending up happy. There is a lot to consider as well here, including which shareholders are of more importance to the company's progress. If the inclusion of Tag Along would be something that aids it, then that's a green signal.
More Samples of Tag Along
