The power of the drag-along

The shareholders´ agreement might seem to contain boiler plate drag along rights. But when the day comes that the company gets an offer to be acquired, the drag along may turn out to be the deal maker and lead to harsh effects for the minority that entered into the startup at a valuation higher than the founders and the majority investors, or in any case where the majority investors (typically savvy VC investors) have preference shares as down-side protection.

This article will get right to the point by providing an example of when and how the drag-along can lead to a minority shareholder being forced to sell even if the shareholder will make a significant loss and even if the shareholder still believes in the company and that the valuation will increase if he/she stays invested.

This is not to say that the drag-along and its function to ensure that the company can be sold as a whole without hold-ups from minority investors is per se a negative - it is only to illustrate its power and how negative it can be in an individual case for individual minority shareholders - and that it is very important to not shy away from such facts when discussing shareholder agreements and the power dynamics between the minority and the majority.

The different timing, valuation and share classes will mean that the incentive and results of a sale will be completely different and the triggers to force someone to sell or to have a right to tag along when someone wants to sell can therefore be extremely powerful and also dangerous. So make sure you have a realistic understanding of the incentives and hurdles that the controlling shareholders have and if those hurdles are harmful for your investment.