Co-sale: Everything You Need to Know
Co-sale rights are the rights of minority shareholders to join in when the majority shareholder or the founders sell their stock.4 min read
2. Why Are Co-sale Rights Important?
3. When Co-sale Rights Should Apply
4. When Co-sale Rights Shouldn't Apply
5. How Co-sale Rights Will Affect Your Company
What Are Co-sale Rights?
Co-sale rights, also known as tag-along or (less often) take-me-along rights, are the rights of minority shareholders to join in when the majority shareholder or the founders sell their stock. Therefore, if the company's original owner sells his or her stock to a corporation for $20 per share, every investor with a co-sale right can get the same deal.
Co-sale rights are usually paired with the right of first refusal, or ROFR. With an ROFR clause, a company or its shareholders can buy the majority shareholder's stock if he or she decides to sell to a third party. This lets the current investors keep control of the company in case they don't like the third-party investor.
For example, say a company called Unlimited Clocks has five founders with 10 percent control each, a venture capital firm that owns 30 percent of the business, and 100 employees and small investors with 20 percent control between them. One day, all five founders decide to sell their stock to Super Unlimited Clocks for $15 per share.
The venture capital firm has an ROFR, so they can buy all the founders' stock for $15 each if they want and cut SUC out of the deal. They also have a co-sale right, so they can sell their stock for $15 to SUC and force them to buy up to 80 percent of the company instead of 50. Some of the employees and small investors might have ROFR and co-sale rights, too, but others might not.
Why Are Co-sale Rights Important?
- Larger shareholders can usually get better deals than smaller shareholders. This is because they are often major companies with great negotiators. It's also because the big investment companies that can offer the best deals like to buy big percentages of companies. Co-sale rights let small shareholders take part in these better deals.
- If a company's founders are all selling, an investor might not want to stick around. A small company's success depends greatly on the people who work there. It can fail quickly if all the important people leave.
- The third party that's buying the stock may have a reputation for figuratively burning businesses to the ground. The ROFR is there to stop that from happening. However, it's usually an all-or-nothing deal: Either the shareholders buy all the stock for sale or none of it. If they can't get the money, the next best thing is to sell their own stake.
When Co-sale Rights Should Apply
- Venture capital firms, angel investors, and other people and businesses that invest in companies want to know they won't be left behind when it is time to pay out. Co-sale rights and ROFR guarantee they will be able to take part in a good deal or stop a bad one from happening.
- Few investors actually use their co-sale rights, but they're still important. By having them, the company's executives will avoid deals that would lead investors to use their co-sale rights.
When Co-sale Rights Shouldn't Apply
- Co-sale rights often have built-in limits on when a shareholder can use them. For instance, majority shareholders and founders can sell or transfer stock to family members. If they die, the stock can transfer to their estate and heirs. Major shareholders can also sell a few stocks each year without activating the co-sale right.
- If you're a founder, you'll want to ensure only a few investors have co-sale rights and ROFR. Companies that want to buy your shares won't like it if all your other shareholders can buy them first. Moreover, they won't like having to buy the whole company when they only want 51 percent. Usually, the common stock that the company's employees (but not always the founders) own won't have ROFR or co-sale rights.
- Co-sale rights generally don't apply to any preferred stock the founders buy back from investors. This stock represents an extra investment in the company outside of their ownership of it. Therefore, the rules for selling it are different.
- Sometimes investors will want to add ROFR and co-sale rights that trigger when another investor sells their share, not just when the founders sell. However, investors don't like it when this happens to them. This is because it makes it harder for them to sell.
How Co-sale Rights Will Affect Your Company
Here's the short answer: They probably won't. Co-sale rights and ROFR are almost always a part of the extra rights that come with preferred stock, which is the stock handed out to a private company's investors. However, investors almost never use these rights. Moreover, if a company starts publicly trading, both these rights disappear.
On the other hand, if many of your investors do use their co-sale rights, you can expect a dramatic change. A new investor with a majority can throw ample weight around. That weight keeps going up if he or she gets even more shares from co-sales. If the investor gets most of your company's shares, that investor can replace all the directors, partners, managers, and other executives as much as he or she wants. Still, this is only a worst-case scenario.
Co-sale rights normally aren't a big deal, but they will come up if you start a company and look for investors. If you need to help with your co sale rights or other parts of equity financing, you can post your legal need on UpCounsel. The lawyers you can meet on our site include graduates of Harvard and Yale Law, and they've helped major companies such as Airbnb, Google, and Menlo Ventures.