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Anatomy of a Term Sheet - Co-sale and Tag-Along Rights

For more information on this post contact Scott Preece.

Like the ROFR, the "Co-sale" and "Tag-Along" further restrict the ability of shareholders to sell their shares. The two terms are often used interchangeably, but in the UK there is a subtle difference between the two.

The “co-sale” right requires a shareholder (usually the founders or ordinary shareholders), before selling any ordinary shares to a third party (but after going through the ROFR), to allow Investors the opportunity to participate in the sale in proportion to the number of shares held by them. Co-sale rights are rarely used in practice, but in theory, allow investors to participate in any liquidity event alongside Founders and other shareholders. 

The "tag-along" requires an acquirer, before purchasing a controlling stake in the company, to make an offer to all other shareholders on the same terms (but subject to any liquidation preference). The tag-along is a "minority protection" which allows minority shareholders to exit a company when there is a change of control (in a lot of respects it is the inverse of the drag-along). You do not tend to see tag-along provisions in US term sheets. 

The co-sale and tag-along provisions are seldom negotiated but there are a couple of things to consider:

  • Who should be subject to the co-sale? Like the ROFR, in the US investors are not typically subject to co-sale provisions as they want to have the ability to freely transfer their shares. In Europe, it is not uncommon for investors/VCs to be subject to the co-sale. If investors/VCs are not subject to the co-sale, consideration should be given as to whether the provisions should apply to ordinary shareholders as a whole, the Founders only, or the Founders and ordinary shareholders with large holdings.
  • Who should benefit from the co-sale? Again similar to the ROFR, in the US, the co-sale usually operates in favour of investors/VCs. In the UK, again it is not uncommon for the co-sale to operate in favour of all shareholders. One consideration is that in the unlikely event that the co-sale is ever exercised, in having the right in favour of all shareholders could be cumbersome and time-consuming, so it is probably advisable to keep the co-sale rights in favour of a small group
  • Exceptions to the co-sale? These usually follow the Permitted Transfers language in the ROFR.
  • Tag-along Threshold? Thought should be given as to what constitutes a "change of control", this may always not be a simple majority of the shares or voting control. Thought should also be given as to how any tag-along right interacts with the liquidation preference (in that the trigger threshold should be the same for both).

The Anatomy of a Term Sheet series can be found in full here.

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