What are Tag-Along Rights?

Tag-along rights are contractual clauses that protect minority shareholders. They are also frequently referred to as co-sale rights. These provisions are typically found in a shareholders agreement or a term sheet during a venture capital deal.

The core concept is relatively simple. If a majority shareholder decides to sell their stake in the company to a third party, the minority shareholders have the right to join the transaction. They can tag along.

This right allows the minority holder to sell their shares at the same price and under the same terms and conditions as the majority shareholder. It essentially guarantees that you do not get left behind if the primary owners decide to cash out.

In the startup ecosystem, liquidity is rare. Your stock is usually illiquid until an exit event occurs. That event could be an IPO or an acquisition.

However, sometimes a majority shareholder finds a buyer for just their specific block of shares. Without tag-along rights, a minority shareholder could find themselves in a difficult position.

You could remain stuck holding illiquid stock in a company now controlled by a new owner you did not choose. This new owner might have a completely different vision for the company or might not be interested in acquiring the remaining shares later.

Tag-along rights provide a safety valve. They ensure that if the ship is sailing, you have the option to get on board. It offers minority investors and founders who have been diluted financial protection and an exit route.

It is almost impossible to discuss tag-along rights without mentioning their counterpart. That counterpart is drag-along rights. These two terms almost always appear together in legal documents, but they serve opposite functions.

• Tag-Along Rights: Protect the minority. They give the minority the option to sell if the majority sells.
• Drag-Along Rights: Protect the majority. They give the majority the power to force the minority to sell if the majority finds a buyer for the whole company.

While drag-along rights ensure that a small shareholder cannot block a massive acquisition, tag-along rights ensure the big shareholders cannot abandon the small ones.

These rights usually trigger during secondary market sales or partial acquisitions. For example, imagine a scenario where a founder owns 60 percent of the company and an angel investor owns 10 percent.

If a private equity firm offers to buy the founder’s 60 percent, the angel investor can exercise their tag-along rights. The buyer must then purchase a proportionate amount of the angel investor’s shares as well.

This forces founders to think about the long-term structure of their cap table.

Does the inclusion of these rights make your company less attractive to a buyer who only wants a controlling stake but not 100 percent ownership?

Does the buyer have the capital to purchase the extra shares if everyone tags along?

As you review your shareholder agreements, you have to weigh the protection of liquidity against the complexity of future deals. It is about balancing fairness with operational flexibility.