Drag-Along, Tag-Along and Rights of First Refusal A Plain Language Guide
Three of the most important clauses in any shareholders agreement govern what happens when someone wants to sell their shares. Every shareholder should understand these before signing.
Why These Clauses Matter
Most disputes in closely-held corporations eventually involve share transfers. Drag-along rights, tag-along rights, and rights of first refusal are the mechanisms that govern who can sell, to whom, at what price and whether other shareholders can participate or be forced to join.
Right of First Refusal (ROFR)
A ROFR gives existing shareholders and/or the corporation the right to buy a departing shareholder's shares at the same price and on the same terms as any third-party offer before those shares can be sold to an outsider.
How it works: Shareholder A receives a third-party offer at $10 per share. A must notify existing shareholders. They have a set period (typically 30 days) to buy A's shares at $10. If they decline, A can sell to the third party but only at $10, not less.
Protects: Existing shareholders and the corporation prevents unwanted parties from becoming shareholders.
Drag-Along Rights
A drag-along right allows majority shareholders to force minority shareholders to sell their shares in an acquisition on the same terms enabling a clean 100% sale without minority holdouts.
How it works: Majority sells to Buyer Corp at $15 per share. Minority (15%) refuses to sell. With drag-along, majority can force minority to sell at $15 per share too, completing a full acquisition.
Protects: Majority shareholders prevents minorities from blocking an exit.
Typical minority protections within a drag-along clause:
- All shareholders receive the same price per share no side deals for majority
- Minority not required to give representations beyond their own title to shares
- Transaction must be a bona fide arm's length deal
- Minimum price threshold before the drag can be triggered
Tag-Along Rights
The mirror image of drag-along. A tag-along right allows minority shareholders to join a sale by a controlling shareholder on the same terms ensuring they are not left behind as minorities under new, potentially hostile ownership.
How it works: Controlling shareholder sells 70% to Buyer Corp at $15. Minority (15%) has a tag-along right and can require their shares also be included in the sale at $15.
Protects: Minority shareholders ensures they can exit at the same premium as the majority.
How They Work Together
| Clause | Protects | Effect |
|---|---|---|
| ROFR | Existing shareholders / corporation | Controls who can become a shareholder |
| Drag-Along | Majority | Forces minority to sell in an acquisition |
| Tag-Along | Minority | Allows minority to join a controlling sale |