Drag along and tag along are legal terms that refer to clauses in a shareholders’ agreement. Together, they help align founders and investors to facilitate the all-important exit.
- A drag-along clause allows majority of shareholders (or a certain group of controlling shareholders) to make other shareholders participate in the event of a sale.
- A tag-along clause, or co-sale agreement, allows minority shareholders to participate (go along) in a transaction led by controlling shareholders, often the founders.
At first glance, the drag along is friendly for founders and the tag along for minority investors, usually angel investors. Digging deeper, they act as a pair to align investors and facilitate a sale or liquidation of the company. See this article by Delvy Law & Finance that provides a great explanation (in Spanish)of the duality of these clauses.
Here are a few parameters for seed stage founders and angel investors:
- Look for these clauses in the term sheet – they will also be in the Shareholders’ Agreement (Convenio de Accionistas)
- In early stages of a startup, the founders should be the controlling shareholders
- Angel investors, as minority shareholders should be able to tag along – they backed the founding team so should be able to go in the team goes
- Seed investors should sign a drag along and tag along clause – this aligns everyone together in one solid group
- Founders should avoid angel investors that seek a drag along clause that allows the investor to drag along the founders – it makes sense to wait (Series A) to share this right
- In later stages (ie. Series A) the venture capital investors often join the controlling group as preferred shareholders that can drag along other shareholders.
Some examples of what these clauses look like in English and Spanish:
Example in Spanish from open-source documents provided by PECAP. You can find them in the Convenio de Accionistas under article 4.3 and 4.4.
“Derecho de acompañamiento (tag along): En caso uno o más de los accionistas que – individual o – conjuntamente tenga más del 50%+1 de las acciones con derecho a voto de la sociedad (“Accionistas Controladores”) reciban y acepten una oferta de un tercero adquirente para la transferencia directa o indirecta del control de la Sociedad; el Inversionista tendrá el derecho y la opción de sumarse a la venta bajo los mismos términos y condiciones y vender todas o una parte de sus acciones.”
“Derecho de arrastre (drag along) “Bajo un escenario de venta de control, los Accionistas Controladores que deseen vender la totalidad de sus acciones en la Sociedad . . . podrán exigir a los demás accionistas de la sociedad. . . la transferencia en venta del íntegro de las acciones”
Example in English from Venture Deals, Second Edition, by Brad Feld and Jason Mendelson:
“Drag-along Agreement: The holders of the (Founders/Common Stock) Series A Preferred shall enter into a drag-along agreement whereby if a majority of the holder of Series A Preferred agree to a sale or liquidation of the Company, the holders of the remaining Series A Preferred (and Common Stock) shall consent to and raise no objections to such sale.”
“Co-sale Agreement: The shares of the Company’s securities held by the the Founders shall be made subject to a co-sale agreement (with certain reasonable exceptions) with the Investors such that the Founders may not sell, transfer, or exchange their stock unless each Investor has an opportunity to participate in the sale on a pro rata basis . . .”