Role and Value of Drag-Along and Tag-Along Rights

In venture capital, investment is not just about providing funding but also about setting clear expectations on how investors and founders manage their ownership and eventually exit their investment as the company grows. Two key tools that help balance these interests — particularly when it comes to the sale of shares and securing liquidity — are drag-along and tag-along rights. These provisions are designed to regulate how shareholders participate in exit transactions, ensuring that both majority and minority stakeholders are treated fairly when ownership changes hands.

What Are Drag-Along and Tag-Along Rights?

Tag-along rights protect minority shareholders when a majority shareholder(-s) decides to sell its shares. They give minority shareholders the right to join the transaction and sell their shares on the same terms as the majority shareholder(-s), protecting them from being left behind or receiving a less favourable deal terms.

Drag-along rights, in contrast, are designed to protect majority shareholders. They allow the majority to compel minority shareholders to sell their shares in a proposed transaction. This helps facilitate clean exits, especially in cases where a buyer demands 100% ownership of the company. Without such a provision, even a small group of minority shareholders could block or delay a transaction that is otherwise supported by the majority.

Why Are These Rights Important for Different Sides?

The practical significance of drag-along and tag-along rights often depends on the stage of the company’s growth and who holds the controlling interest at any given time. These rights do not operate in a vacuum — they shift in relevance as the cap table evolves through multiple investment rounds.

In the early stages, when founders typically hold the majority of voting rights, drag-along rights serve as a protection primarily for founders themselves. With majority control, founders can ensure they are not blocked by minority investors if an attractive acquisition offer arises. On the other hand, investors — often holding only minority positions — benefit more from tag-along rights at this stage. Tag-along provisions allow them to participate in the founders’ exit and avoid being left behind and secure liquidity on the same terms as the seller.

As the company matures and larger or multiple investors gain majority or controlling stakes, the dynamics reverse. Investors, now holding control, turn to drag-along rights to secure clean exits without founder or minority interference or block. In these later stages, founders and early shareholders become the minority, making tag-along rights critical for their protection. These rights ensure they are not sidelined when institutional investors negotiate an exit with a buyer seeking majority or full ownership.

In both scenarios, these rights help balance the power dynamics between shareholders at different stages of the company’s lifecycle. Whether the majority is held by founders or investors, drag-along and tag-along rights function as essential tools to manage exit risks and maintain fairness. However, their value—and the leverage to negotiate their terms—shifts over time, depending on who holds control.

The Mechanics Behind Drag-Along and Tag-Along Rights

While commonly used, drag-along and tag-along rights can vary significantly depending on how they are drafted. Small differences in wording often have a big impact on their practical effect.

A key feature is the triggering threshold, typically defined as a percentage of share capital, such as 51% or 75%. Some clauses go further, requiring the consent of specific shareholder groups, like preferred investors or founders, adding extra layers of control.

It is also common for drag-along rights to be conditional on a minimum transaction value, agreed in advance, to ensure minority shareholders are not forced into a low-value sale — especially one below the valuation at which investors have invested, or below a threshold needed to secure their expected return, for example, at least a 2x multiple on their investment.

Tag-along rights may differ in how much minority shareholders can sell. The standard approach allows for pro rata participation, meaning they sell a proportion of their shares. However, some agreements offer full tag-along rights, letting minority holders sell all their shares. While protective, this can complicate deals by reducing the shareholders’ liquidity to sell their shares.

Procedural elements like notice periods also affect the timing and execution of these rights. Longer decision windows offer flexibility but may delay transactions.

In all cases, the specific structure matters. Thresholds, consents, valuation protections, and participation terms must be carefully aligned with the company’s ownership and exit strategy. These details determine how the rights work in practice, and their impact changes as the cap table evolves.

Conclusion

Drag-along and tag-along rights are more than just standard clauses in shareholder or investment agreements — they are essential tools for managing control, protecting shareholder interests, and ensuring liquidity for investors in company sale scenarios. Their real impact depends on how they are structured in each deal, including thresholds, consent requirements, valuation protections, and participation terms.

As the balance of power shifts over time, these rights must be carefully tailored to reflect the company’s cap table at each stage — whether control lies with founders, early investors, or later-stage funds. Poorly drafted or generic clauses may fail to deliver the expected protections or flexibility when exit opportunities arise.

Ultimately, achieving the intended outcomes requires clear, deal-specific drafting and forward-looking negotiation, ensuring these rights serve as practical, enforceable tools — not just formalities, as they can directly impact the liquidity of shareholders’ investment in the company’s shares.

The information in this article is general and not intended as legal advice. It is for information purposes only and does not reflect any particular situation or circumstances and should not be relied upon as a source of professional advice.

Author: Jēkabs Senkāns, Lawyer in SIA “Venture Faculty”