Raising equity investment is exhilarating, but the contracts you sign during a funding round will decide who controls and who ultimately profits from your business. One pair of clauses deserves particular attention: drag-along and tag-along rights.
They dictate what happens to every shareholder’s stake if a buyer makes an offer for the company, and their wording often becomes a sticking point during term sheet negotiations. This article looks at how drag and tag rights work in practice, why they matter for founders and investors, and what to watch out for before you close a deal.
What are Drag-Along and Tag-Along Rights?
When investors make an investment, they are already thinking about how to get that money back (preferably multiplied) within a predictable time frame. Trade buyers and private equity funds, in turn, want the certainty that they can acquire all the shares without a minority hold-out scuppering the transaction. Drag-along and tag-along rights provide this reassurance by managing the way shareholders exit when a buyer appears:
- Drag-along rights let a specified majority of the holders of voting shares compel all other shareholders to sell on the same price and terms once a qualifying offer is made. Earlier seed rounds often set the bar higher, while later VC rounds tend to use a lower one. This gives buyers the certainty of full ownership, and institutional investors insist on the clause so that no minority can block a sale.
- Tag-along rights protect minority shareholders. If the majority accepts an offer for its own shares and the buyer does not insist on buying 100% of the share capital, the majority must secure an identical offer for everyone else. The minority can tag into the deal or remain invested, but they cannot be left behind under a new owner.
Together they influence valuation, control and liquidity, so it’s important that these clauses are drafted carefully and aligned across all documents.
Drag-Along and Tag-Along Rights in Practice
In most UK companies the rights often appear in both the Articles and the Shareholders’ Agreement. When a genuine offer to buy the company arrives, the first documents investors check are the drag-along and tag-along clauses. Here is how those rights are actually put to work:
- Buyer makes an offer for the company.
Most acquirers want 100% of the shares, so the deal will only proceed if every shareholder sells.
- Required majority accepts the offer.
Once shareholders holding at least the drag threshold agree to sell, they can trigger the drag-along.
- Drag notice is served.
The majority (usually acting through the board) issues a formal drag notice to the remaining shareholders. The notice sets out the price per share, the completion timetable and any warranties each seller must give.
- Compulsory transfers are completed.
From receipt of the notice, minority holders must sell on the same terms. If anyone refuses to sign the stock-transfer form, the Articles usually authorise a director to sign on that shareholder’s behalf (provided the Articles include this power).
- Tag-along check.
If the majority is selling only part of its holding, the board must confirm whether the tag-along clause is triggered. If so, they must secure an identical offer for every other shareholder.
- Minority choice under the tag.
Each minority investor can accept the offer and exit or keep their shares and remain under the new majority owner. Either way, they are not stranded with inferior terms.
Typical Drafting Pitfalls and How to Avoid
Investors treat drag-along and tag-along wording as a barometer of how “exit-ready” your company is. Any drafting flaw they find during due diligence can slow the raise, chip away at valuation, or even prompt a demand for fresh Articles before they send funds. Keep an eye on these common traps well before you circulate a term sheet:
- Mismatched triggers. Keep the percentage threshold, valuation floor and definition of a “qualifying offer” identical in every document (Articles, Shareholders’ Agreements and option deeds) so no one can exploit a technical gap.
- Partial-sale loopholes. Word the drag-along so it catches a “series of related transactions”, not just a single sale, otherwise a controlling block could be transferred in stages and dodge tag rights.
- Excessive warranties. Minority shareholders dragged into a sale should give only “title and capacity” warranties, with liability commonly capped at (or linked to) the amount each seller receives.
- Forgotten option holders. Ensure EMI or unapproved options are covered, either by a deed of adherence or explicit clause, to prevent last-minute dilution when options convert.
A brief, pre-term-sheet review by corporate counsel will usually flag these issues early, allowing tidy corrections before investors start their due diligence checks.
Preparing for Your Next Raise
Long before you send a draft term sheet to investors, a little groundwork can prevent delays, protect valuation, and minimise legal costs. Use the breathing space between rounds to tackle the following tasks.
- Audit your documentation thoroughly. Pull together the current Articles of Association, Shareholders’ Agreement, option deeds, and any side letters. Check that every shareholder (including former employees and option-holders who have exercised) is bound by the same drag-along and tag-along clauses.
- Model a range of exit scenarios. Work with your finance team (or an adviser) to run waterfall calculations at different valuations, factoring in conversion ratios, preference stacks and option pools. Seeing how the proceeds split highlights whether the clauses really deliver equal treatment and let you adjust terms before investors run their own numbers.
- Secure consents well ahead of time. Amending the Articles or Shareholders’ Agreement often needs either special resolutions (75 per cent of voting shares) or unanimous written approvals. Tracking down legacy investors or overseas angels can take weeks, so start the process early and keep clear records of who has signed.
- Prepare a concise rationale for your thresholds. Prospective investors will challenge the percentage that triggers a drag and the scope of your tag rights. Be ready to explain why the levels you have chosen preserve founder influence while still giving acquirers confidence they can buy the whole company.
- Bring in specialist advisers at the term sheet stage, not the day before signing. Corporate lawyers who handle funding rounds daily will spot hidden conflicts such as a tag clause that covers ordinary shares but omits convertibles, long before they reach the due diligence phase. Early input is usually cheaper than last-minute redrafting and demonstrates professionalism to investors.
Talk to the experts at JPP Law
JPP Law’s corporate finance team helps founders, angel syndicates and venture funds navigate the fine print of fundraising, from first term sheet review through to ultimate exit. If you would like tailored advice on drag-along and tag-along rights, contact JPP Law today.
