What are Drag-Along Rights?

The drag-along rights clause gives power to the majority shareholders of a firm by which they can “drag along” the minority shareholders to sell their stake in the company at the time of a merger or acquisition.

For example, Company ABC is listed on the exchange. A larger company, XYZ, has managed to purchase more than 51% of ABC’s shares from the markets and other owners of the firm, due to which there is an acquisition cited in the future for ABC by XYZ. However, XYZ wishes to own the company ABC “fully,” which means they wish to hold a 100.0% stake in ABC without sharing any ownership with minority shareholders. In this case, most shareholders would force the minority shareholders to sell their stake. In other words, the majority of shareholders are exercising their drag-along rights.

Features of Drag-Along Rights

The drag-along rights clause is significant both for the issuing company and the buyer. Some significant points are:

  • At a merger and acquisitionMerger And AcquisitionMergers and acquisitions (M&A) are collaborations between two or more firms. In a merger, two or more companies functioning at the same level combine to create a new business entity. In an acquisition, a larger organization buys a smaller business entity for expansion.read more, the issuing company may want to sell its ownership to the new buyer firm. For this, the majority of shareholders would already have decided to sell their shares, but what about the remaining shares held by the smaller chunk of shareholders? The issuing company, in this case, can exercise its drag-along right and force the minority shareholders to sell their shares too.The minority shareholdersMinority ShareholdersMinority interest is the investors’ stakeholding that is less than 50% of the existing shares or the voting rights in the company. The minority shareholders do not have control over the company through their voting rights, thereby having a meagre role in the corporate decision-making.read more, while forced upon with this right, are offered the same price that the potential buyer of the firm or any other buyer in the market offered them directly. Thus, there is equal competition for the majority shareholdersMajority ShareholdersA majority shareholder or controlling shareholder is an individual or a corporation that owns the majority of the company’s stock (more than 50%) and therefore enjoys more voting power than other shareholders. These shareholders are in a position to influence the company’s decisions.read more as for any other buyer in the market.The drag-along rights clause is a plus for the potential buyer of the firm since he gets the entire ownership of the firm. It helps them to run the firm as per their policies.Terms and conditions regarding the exercise of the drag-along rights clause are generally mentioned in the offer documents at the time of the issue of securities. Thus, the investors should be well-versed with the conditions of their stake in the company before any investments.

While this right has its significance, it has certain benefits too. Some benefits for the parties are:

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#1 – Majority Shareholders

The majority of shareholders who also form a part or whole of the owners of the company exercise this right at the time of mergers and acquisitions only because there is a benefit to them. During M&As, the buyer may pose a condition that they require 100% ownership in the acquired company and may offer a little extra than that offered. The owners may receive more by exercising these drag-along rights in such a case.

#2 – Minority Shareholders

A clause protects the rights of minority shareholders as per which they shall be paid the same amount for selling their stake in the company that any other seller would have paid in the market.

#3 – Buyers of the Company

For the buyers, the biggest benefit is that they get 100% ownership of the firm. It eliminates disturbances from their procedures and policies to run the company. Even if they are required to pay a higher amount to acquire the concerned company, they are interested since it ensures a means to run the company better.

Some Facts about the Drag-Along Rights Clause

The drag-along rights clause has come into existence because of their benefits and The drag-along rights clause has come into existence because of its benefits and monopoly posed by most shareholders. However, there are a few facts that all shareholders of any company need to know should they face any such situation with the shares they hold:

Conclusion

The drag-along rights clause may seem beneficial in different ways to all the parties involved in the transaction; however, there are a lot of critical points that need to be taken care of by all stakeholders. There requires a lot of analysis by buyers and sellers of the company before proceeding with any such transaction. There may also lie some contingency at the end of minority shareholders, which can cause delays in the finalization of the deal. One of the best ways to proceed with this situation is to mention all intricate details in the offer document at the time of issue so that all the parties are well aware of the prospects of the issue.

Drag-Along Rights Video

This article has been a guide to what are Drag-Along Rights? Here we discuss the features of Drag-along rights along with its benefits to the majority shareholder, minority shareholders, and the buyer. You may learn more about Private Equity from the following articles –

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