11 May 2018

Tag along rights in shareholders agreements

Tag along rights give a shareholder the right to join (or 'tag along' with) another shareholder if they find a buyer for their shares. They can be an important protection for minority shareholders.


 

What are tag along rights?

A tag along clause will prevent a key shareholder, or group of key shareholders, from selling their shares without giving the other shareholders a right to participate (or 'tag along') in the sale.

Tag along rights can be an important protection for an investor or other minority shareholder in a shareholders agreement.

Why would you want tag along rights?

If you are an investor or minority shareholder, there are two reasons why you might want tag along rights:

  • you would normally want the opportunity to sell your shares and realise the value of your investment at the same time as other shareholders; and
  • if the success of the business is likely to be dependent on the ongoing involvement of a key shareholder, you may want the opportunity to sell down (or out) if that person ceases to be a shareholder.

If you are an investor, there are other things you should look for in a shareholders agreement, as we explain here.

How are tag along clauses structured?

Tag along clauses typically work in one of two ways.

The first type of tag along clause allows all shareholders to participate in the sale proportionally. For example, if you own 10% of the company's shares and you have a tag along right, you would be given the opportunity to sell 10% of the total parcel of shares that are being sold. This type of clause would typically result in shareholders selling some of their shares, but none of them being able to sell all of them.

The second type of clause prevents a key shareholder from selling their shares unless the entire company is sold.

There can be variants of the above clauses, some of which address the situation where some shareholders (but not all) wish to 'tag along'.

Exceptions and concessions for the key shareholder

It is not uncommon for a key shareholder to seek exceptions to a tag along clause.

If you are a founder or other key shareholder who may be subject to a tag along provisions, it is important to keep this in mind. Although most (informed) investors will insist on tag along provisions, and you may have to agree to them, many investors will also be willing to grant concessions.

For example, as the key shareholder, you might ask for a small portion of your shares to be exempt from the tag along clause - so that if you can find a willing buyer, you can be permitted to sell those shares and be partially rewarded for your contribution, without diluting other shareholders.

A different type of exception could be based on the achievement of a particular milestone (eg a profit or value milestone), or the passage of a period of time. This type of exception could apply to all shares held by the key shareholder, or a small portion.

If you are investor, it is important to ensure that key shareholders remain committed and motivated. Granting concessions to the tag along clause can be one way of doing this.

Allowing an exception to a tag along clause and permitting a key shareholder to sell a small proportion of their shares can provide a tangible benefit to the shareholder without having any detrimental effect on anyone else (or the business).

Other considerations

When preparing a shareholders agreement, it will be important to consider how the tag along rights will tie in with other clauses that regulate the sale of shares, particularly pre-emptive rights. For example:

  • Should the tag along rights apply if an existing shareholder wishes to buy the shares from the key shareholder?
  • Should the key shareholder be required to offer their shares for sale to the existing shareholders before offering them to a potential external investor?

The answers to these questions will depend on your circumstances.

The main considerations will be the composition of your share register and the extent to which the company's success is dependent on specific shareholders, the maturity and profitability of the business, and the shareholders' intentions generally in relation to an exit or other liquidity event.New Call-to-action

About the Author

Greg Henry | Principal

Greg is a principal at Turtons and a senior commercial lawyer who acts for a range of clients mainly in the construction and technology sectors. Greg advises on both transactional and contentious matters.


greg.henry@turtons.com | (02) 9229 2904

About Turtons

Turtons is a commercial law firm in Sydney with specialist expertise in privately owned construction and technology businesses.

Greg Henry | Principal

Author

Greg Henry | Principal

greg.henry@turtons.com

Greg is a principal at Turtons and a senior commercial lawyer who acts for a range of clients mainly in the construction and technology sectors. Greg advises on both transactional and contentious matters.


greg.henry@turtons.com | (02) 9229 2904

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