Drag-along, tag-along, and co-sale rights – navigating shareholder exit protections

read time: 5 mins

15.01.25

Ashfords

In venture capital deals, drag-along, tag-along, and co-sale rights are crucial mechanisms that govern shareholder exits. These provisions manage the balance between facilitating exits for the majority shareholders and protecting minority shareholders from being left behind or unfairly treated. While these terms may not come into play daily, they are vital in the event of a sale or transfer of shares.

This article in our ‘Anatomy of a term sheet’ series unpacks the mechanics of these rights, explains their role in a venture-backed company, and highlights how they align with the interests of both founders and investors.

What are drag-along rights?

Drag-along rights allow majority shareholders to compel minority shareholders to sell their shares in the event of a sale of the company. The goal is to ensure that a potential buyer can acquire 100% ownership without being blocked by minority shareholders.

How drag-along rights work

Drag-along rights are typically triggered when a defined majority (e.g., 75% of shareholders) approves the sale.
Minority shareholders are required to sell their shares on the same terms and conditions as the majority.
The provision ensures that minority shareholders cannot disrupt a transaction that benefits the majority.

Example:

A company with three shareholders (investor A: 70%, founder B: 20%, founder C: 10%) receives a buyout offer:

If investor A wishes to sell, drag-along rights allow them to compel founders B and C to sell their shares as well.
All shareholders sell their shares under the same terms, enabling the buyer to acquire the entire company.

What are tag-along rights?

Tag-along rights, also known as co-sale rights, protect minority shareholders by allowing them to join in a sale initiated by majority shareholders. These rights ensure that minority shareholders have the opportunity to sell their shares on the same terms as the majority.

How tag-along rights work

When a majority shareholder sells their shares, tag-along rights give minority shareholders the option (but not the obligation) to participate in the sale.

This prevents majority shareholders from exiting while leaving minority shareholders behind with a potentially less attractive buyer or governance structure.

Example:

In the same company, if investor A sells 70% of the shares:

Founders B and C can invoke their tag-along rights to sell their respective shares under the same terms, ensuring they share in the exit opportunity.

What are co-sale rights?

Co-sale rights are similar to tag-along rights but are more narrowly focused. They allow specific shareholders, typically investors, to sell a proportionate amount of their shares alongside other shareholders who are selling.

How co-sale rights work

Co-sale rights often apply in secondary transactions where founders or other early shareholders sell shares to a third party.
Investors can sell a percentage of their shares to maintain proportional ownership or liquidity.

Example:

If founder B intends to sell 20% of their shares:

Investor A can invoke co-sale rights to sell a portion of their shares in the same transaction, ensuring they have equal access to liquidity.

Key considerations for structuring exit rights

Defining the trigger thresholds

Drag-along rights are usually triggered by a supermajority of shareholders (e.g., 75%), ensuring that smaller groups cannot compel a sale.

Tag-along and co-sale rights typically apply whenever a shareholder seeks to transfer a significant portion of their shares.

Alignment of terms

Minority shareholders must receive the same price, terms, and conditions as majority shareholders when rights are triggered. This ensures fairness in the distribution of proceeds.

Interaction with articles and shareholders’ agreement

Drag-along, tag-along, and co-sale rights should be clearly outlined in the company’s articles of association or shareholders’ agreement to avoid conflicts.

Exceptions and exemptions

Transactions involving transfers to affiliates or family members are often exempt from these provisions.
Drag-along rights may not apply to non-cash transactions unless explicitly agreed.

Example of exit rights in a term sheet

Clause example:

"drag-along rights: in the event that shareholders holding at least 75% of the issued share capital approve a sale of the company, all other shareholders shall be required to sell their shares on the same terms and conditions as the approving shareholders.

Tag-along rights: in the event of a sale by any shareholder holding at least 10% of the issued share capital, all minority shareholders shall have the right to sell their shares on the same terms as the selling shareholder."

Analysis: founders’ perspective vs investors’ perspective

	Founders’ perspective	Investors’ perspective
Motivations	Founders want flexibility in managing their equity while ensuring they are not unfairly forced into a sale or excluded from an exit opportunity.	Investors want to ensure liquidity and maximise value in exit scenarios, while protecting their proportional equity and control.
Preferred position	Drag-along rights with a high approval threshold (e.g. 75%) to prevent minority shareholders from being unfairly compelled. Strong tag-along rights to ensure they can participate in any sale initiated by majority investors. Exemptions for small-scale or personal transfers.	Drag-along rights to facilitate clean exits, particularly in later stages. Tag-along rights to maintain fairness in liquidity opportunities. Co-sale rights to ensure liquidity during secondary sales by founders or other shareholders.
Risks	Drag-along rights could force founders to sell their shares prematurely, while limited tag-along protections may leave them stranded with a less favourable ownership structure.	Restrictive thresholds or exemptions could impede their ability to execute a sale or dilute their returns in exit scenarios.
Where they align	Both founders and investors benefit from clear, well-structured exit rights that balance liquidity with fairness. Fair tag-along provisions ensure minority shareholders are not disadvantaged, while appropriately designed drag-along rights enable smooth transactions that maximise overall value.

In summary

Drag-along, tag-along, and co-sale rights are essential tools for managing shareholder exits in venture capital-backed companies. By balancing the interests of majority and minority shareholders, these provisions provide clarity and fairness while ensuring that exit opportunities are maximised.

Read the next article in our "Anatomy of a term sheet" series, where we explore pre-emption rights, delving into how these provisions protect equity during future funding rounds and share transfers.

If you're navigating the complexities of venture capital term sheets or preparing your business for investment, our experienced team is here to help. Get in touch to discuss how we can support you in securing the right deal for your business.

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