What Are Tag Along Rights?

Tag along rights or "co-sale rights" are legal agreements that guarantee minority stakeholders the right to sell their shares in the company at the same time and under the same conditions as the majority stakeholder. These rights are often used when companies are founded and capitalized because it protects investors and encourages them to buy the company's stock at an early stage. This is especially true for most angel investors, who won't even think of joining unless there are tag along rights.

Why Are Tag Along Rights Important?

Tag along rights protect minority stakeholders by giving them a certain amount of control over their own investments. If a principal stakeholder of the company liquidates its share, smaller investors won't get a bad deal. In simple words: If Investor A is selling their interest in the company, Investor B gets to sell their interest on the same terms and conditions.

While all stakeholders are guaranteed some rights under the Articles of Association of the Limited Company, they need extra protection. The Articles of Association of the company and the Companies Act, 2013 define tag along rights to the shareholders of a private limited company.

Reasons To Consider Using Tag Along Rights

Using tag along rights is a good way to offer legal and financial protection for employees and smaller investors.

One of the main benefits of the closure in the shareholder contract for smaller investors is that a larger shareholder would have the means, grounds, and legal knowledge to negotiate a better deal than the smaller investors could. This means that employees and common share holders will get a better deal than they could normally make on their own.

Finally, when it is hard to find buyers for shares during the liquidation process, tag along rights make it easier for smaller investors to grab the opportunity when it comes along.

Reasons Not to Use Tag Along Rights

Tag along rights aren't always useful for the company's management or majority shareholders. These rights could make it more difficult to bargain for liquidation deals. If the investor is looking to buy a certain amount of shares and knows that they must buy minority shares as well, they might offer a different price or condition.

Also, if tag along rights exist, majority shareholders might gain control of a large part of the company if they buy minority shareholders' stock. This could cause management issues and uncertainty among the rest of the shareholders.

Instead of using tag along rights, the company can use preemptive rights, which allows investors to buy shares being offered for sale before third parties have the chance to grab any.

Examples of Using Tag Along Rights

Let us assume that Investor A holds 75 percent of the shares, while Investor B holds 25 percent. If Investor A sells his or her shares, the remaining 25 percent of the shares might lose value, and Investor B will lose money. Investor B will also have to deal with changes when a new entity owns the majority of the shares.

With tag along rights, Investor B can sell his or her shares at the same price as Investor A and get the same return on the investment. If the person or company buying the majority shares does not offer to buy the remaining 25 percent of the shares, that breaks the tag along rights agreement.

Common Mistakes

Not clarifying the terms of tag along rights is one of the main mistakes. The company needs to define exactly what a majority stakeholder is. In some cases, this is defined as 51 percent, but this must be clearly stated in the shareholder contract.

Tag along rights often only apply to particular types of shares. This means that while all shareholders might assume that they are getting the same deal as the majority stakeholder, this is not the case.

When the limited liability company has a complicated ownership structure, it is necessary to determine crossclass tag-along rights as well. This will increase the dependency of shareholders and cut the risk of one sale disadvantage to the rest of the investors.

Offering tag along rights is not always useful for the company. Dilution of the company's shares is sometimes good, and different scenarios need to be considered before adding tag along rights to the agreement.

Further, tag along rights are often a subject to bargaining. For example, in exchange for providing these rights to minority investors, majority stock holders often restrict their rights to object or block a sale or agreement.

Tag along rights often affect stakeholders' right of first refusal.

Frequently Asked Questions

  • What are tag along rights?

They are pre-negotiated rights provided to minority investors that allow them to get the same terms and condition of sale as the majority shareholder if he or she ever sells his or her interest in the company. The buyer must offer to buy the minority investors' interest at the same price and condition as the main shareholder's interest.

  • What is the difference between tag along rights and drag along rights?

Tag along rights are there to protect small investors, or minority shareholders. It gives them the right to get the same deal as the majority investor. Drag along rights, on the other hand, protect the majority stakeholder's interest by preventing liquidation of the stock and allowing them to force minority share holders to sell their stock at the same terms as they do.

  • Is tag along rights included in all shareholder agreement?

No, they are not. It is a clause that is a subject to negotiation. Some agreements include it, while others do not have this provision.

  • Who benefits from tag along rights?

Generally speaking, minority stakeholders benefit from tag along rights, as they get the option to liquidate their shares at the same price as influential investors in the company.

  • Do tag along rights make it easier to sell shares in a company?

In some cases, it does. If a buyer knows that the shareholder's document includes tag along rights clauses, they might be forced to offer to buy more shares than they want to hold in the company.

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