What are Tag-Along Rights?
Also called co-sale rights, tag-along rights allow minority shareholders to sell their stakes in a company if a majority shareholder wishes to sell its stake in a company.
How Do Tag-Along Rights Work?
Let's say Company XYZ is a start-up firm looking for capital. It puts together a business plan and talks to dozens of potential investors, many of whom buy shares. Company XYZ is careful to offer these shares with tag-along rights.
Company XYZ also talks to a venture capital firm, which agrees to invest so much money that it becomes a 55% owner in the business (giving it the majority interest).
The venture capital firm helps run the company and make it a success. Five years later, it wants to sell its stake in the business and finds a buyer, Company A, which offers to buy the shares for, say, $20 each. Because the minority shareholders have tag-along rights, they can join with the venture capital firm and offer their shares for sale to Company A at $20 too.
Why Do Tag-Along Rights Matter?
Tag-along rights are usually good for minority shareholders because they allow the shareholders to capitalize on a deal that another shareholder is able to strike. In particular, a majority shareholder may have access to potential buyers and may be able to negotiate better terms or pricing than the minority shareholders can. Additionally, it can be difficult to find buyers for shares of private companies; having tag-along rights allows minority shareholders to jump on an opportunity at liquidity.
One downside of tag-along rights is that the buyers of those shares (Company A, in our example) can end up with a very large majority interest in the acquired company, which may unsettle the remaining shareholders and may mean a new board of directors or new management is on the way.