Becoming a minority shareholder or investor in a business may lead you to believe that, given the limited rights you will have, there are not many important considerations to take into account. However, even a minority investor needs to protect their interests as much as possible and to be able to share or exit its investment in a fair manner.
‘While minority shareholders may not usually benefit from voting rights, it is important to ensure they have access to drag along or tag along rights which provide them with a fair exit,’ comments Daniel Gresswell, Partner and Commercial solicitor at Wollens.
‘All investors need to know what their rights will be when it comes to choosing to sell their shares, or if the other shareholders want to sell a part or all of the business.’
What are tag along rights?
Tag along rights afford minority investors protection from being left behind when the majority shareholders agree to sell their shares to a third-party buyer. The buyer will be obliged to make an offer to purchase the minority stakeholders’ investment too.
Ordinarily, the same price and conditions ought to be offered to the minority shareholders but, unlike drag along rights, this is not a forced sale and so the minority shareholders could refuse to sell their stake.
In this respect, tag along rights are considered better protection for minority shareholders than pre-emption rights. If the minority shareholders have pre-emption rights attached to their holding, they would have the first right of refusal on a majority shareholder’s shares, but this may not work if minority shareholders do not have the funding for such a buy-out.
What are drag along rights?
As the name suggests, drag along rights are less appealing than tag along rights for any minority shareholder. When majority shareholders instigate a sale of their investments, drag along rights effectively force minority shareholders to sell to the third party which is taking the majority shares too.
Drag along rights do require the purchaser to offer pricing and conditions on the same level to both minority and majority shareholders. When majority shareholders drag minority shareholders along, unfortunately there is no choice but to sell for the minority shareholders.
Advantages and disadvantages
Whether one considers these rights as an advantage or disadvantage very much depends on the investment strategy of the minority shareholder. For example, here are three scenarios to illustrate the different considerations.
- Impact on investment. If you anticipate or model your investment strategy on long-term growth in the business and you are forced to sell through drag along rights, that could clearly impact your return on investment, especially if the pricing for the shares is lower than anticipated. In contrast, tag long rights offer the opportunity to sell (perhaps at a higher price if offered) that the minority shareholders may not have been otherwise afforded.
- Pricing impact. Drag along rights are typically seen to favour majority stakeholders so that they can make their investment sale more appealing to third parties who want to buy the business outright without any residual minority shareholding remaining. This usually benefits all shareholders, if the buyer increases their valuation of the business and the purchase price reflects this across the board. However, market fluctuations and the reason for the sale could negatively impact the pricing too, for example if the majority shareholder is forced into a fire sale due to insolvency, you will have to share in any reduction in the valuation.
- Secure exit route. You would be keen to avoid a situation where the majority shareholder sells without you and you are then forced into a joint venture with a buyer or purchaser whom you had no connection or prior business relationship with. This is how tag along rights can take away that uncertainty from minority shareholdings.
Negotiation tips
Given the breadth of issues to review, risk assess and agree as you negotiate your investment, careful consideration of the wording on drag along or tag along rights will be critical to securing an equitable exit and in strengthening your minority position.
Our experienced lawyers will discuss your objectives, and some of the ways in which your minority holding could be protected include:
- Tag along rights for any sale of shares by the majority shareholder. It is important that a few words do not result in the difference between tag along rights being triggered and the rights being rendered useless. For example, if the rights only trigger when all of the majority shareholder’s shares are sold, then it could leave the door open for the majority shareholder to sell most (not all) of its shares at a decent price without triggering the tag along rights.
- Minimising representations and warranties. Arguably, when a minority stakeholder is forced to sell through the drag along rights, the buyer may seek to obtain the same level or near same level of representations and warranties from all shareholders it is buying from. However, there is a compelling need to protect the minority shareholding when drag along rights are used and to reduce the minority exposure further.
- Non-cash consideration. The sale of shares can be in the form of cash or non-cash consideration. In the case of the latter, an accurate valuation will be critical and also understanding the impact of any non-cash consideration will require diligent negotiations. For example, if non-cash consideration is in the form of a share transfer which no longer gives minority shareholders tag along or drag along rights, this would risk minority shareholders being forced into an investment with an unknown buyer and their investment taking on a different form to what they originally had signed up for.
How we can help
An investor should not discount the need for professional advice by virtue of the fact that they have a minority stake in a business. Your investments matter and should be fully protected.
We have a strong team of experts across corporate, commercial, and financing which will allow us to deliver you streamlined, comprehensive advice to help you navigate the rights afforded to you in a shareholder agreement so you are protected as best as possible.
For an informal discussion, please contact Daniel Gresswell in the corporate and commercial team on 01392 539190 or email [email protected]
You can also complete an online enquiry form. One of the Wollens team will contact you as soon as they are available.
