Drag-along rights allow majority shareholders to force minority shareholders to participate in a sale of the company on the same terms. They exist to prevent minority holders from blocking a transaction that the majority has already approved. Standard in most venture financing, drag-along is typically triggered once holders of a specified percentage of shares, often 50 to 70 percent of preferred and common combined, vote to approve a sale.
Drag-along rights prevent minority shareholders from blocking a sale that the majority wants to complete. Without them, a single small shareholder could hold up an entire acquisition.
These rights are standard in most venture deals and protect both sides: investors who may want to sell, and founders who may want to sell even over the objection of a smaller investor, depending on where the threshold is set.
If shareholders holding more than the agreed threshold, commonly 50 to 70 percent of preferred and common combined, or sometimes just preferred, approve a sale, every other shareholder must sell on the same terms. The dragged shareholders receive the same price per share and the same terms as the majority that approved the deal.
Say a company's shareholder agreement sets the drag-along threshold at 60 percent of preferred and common shares combined. If holders of 65 percent of the company vote to accept a $40 million acquisition offer, the remaining 35 percent, including any founder or employee who disagreed, must sell their shares into the deal at the same per-share price and terms.
Not understanding exactly who holds the power to trigger drag-along is a common gap, since the approval threshold varies significantly deal by deal. Drag-along combined with a large liquidation preference can also mean common shareholders end up with very little in a modest exit, so model that scenario before you sign, and have a startup lawyer review the actual language in your documents.
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