Tag-along rights, in German Rights of first refusal, give minority shareholders the right to sell their shares in the company at the same time if majority shareholders sell their shares to buyers.
Minority shareholders are, in principle, entitled to offer their shares on the same commercial terms. This prevents majority shareholders from benefiting from an attractive offer to sell, whilst the remaining shareholders are left with new, potentially unwelcome shareholders in the company.
A simplified example:
| Parties involved | Proportion |
| Founder A | 60 % |
| Founder B | 25 % |
| Investor | 15 % |
If Founder A wishes to sell a 60 per cent stake to a buyer, Founder B and the investor may, by virtue of their tag-along rights, demand the right to sell their shares on the same terms.
Tag-along clauses often stipulate that:
- at what level of shareholding does the right of first refusal apply?
- which shareholders are protected
- what proportion may be sold as part of the sale
- at what price the sale takes place
- What payment and contract terms apply?
- the time limit within which the right must be exercised
- be kept informed in the same way as the other shareholders
Tag-along rights offer minority shareholders the following advantages in particular:
- Participation in an attractive exit offer
- Protection against an undesirable change in the balance of power
- Equal treatment in terms of price and terms of sale
- a lower risk of being left holding hard-to-sell minority shareholdings
- a stronger negotiating position vis-à-vis majority shareholders
For majority shareholders and potential buyers, however, tag-along rights can make the sale process more complex. Buyers may have to acquire additional shares or adjust the planned scope of the transaction.
Tag-along rights differ from drag-along rights:
| Tag-Along Rights | Drag-Along Rights |
| Minority shareholders are entitled to sell their shares. | Minority shareholders may be required to sell their shares alongside other shareholders. |
| are primarily intended to protect the minority | facilitate the sale of the entire company |
| voluntary exercise by the entitled parties | Compulsory attendance provided the requirements are met |
In shareholding agreements, tag-along and drag-along rights are often dealt with together. In such cases, the triggering events, time limits, shareholding thresholds and terms of sale should be clearly set out.
A common mistake is simply to state that a right of co-sale exists, without setting out the specific terms of that right. Any ambiguities may later lead to disputes over the sale price, the extent of the shares sold as part of the transaction, or the allocation of transaction costs.
innoWerft helps founders to better understand equity structures and typical provisions in funding agreements, to assess their implications for future funding rounds and exit scenarios, and to prepare for discussions with investors.