If you’ve been through a funding round — or you’re about to — you’ve probably encountered the phrase “customary drag and tag provisions” in a term sheet. It sounds innocuous. Most founders gloss over it. That’s a mistake.
Drag-along and tag-along rights are among the most consequential clauses in any shareholders agreement. They determine what happens when someone wants to sell the company — or part of it — and they directly affect whether you, as a founder or minority shareholder, get a seat at the table or get dragged out the door.
Here’s what you need to know.
What Are Drag-Along Rights?
A drag-along right allows shareholders holding a specified majority — typically somewhere between 51% and 75% of the shares — to force all other shareholders to sell their shares to a third-party buyer, on the same terms and conditions.
The logic is straightforward. A buyer who wants to acquire the entire company doesn’t want to deal with a handful of minority shareholders who refuse to sell. Drag-along rights solve that problem by giving the majority the power to compel a complete sale.
In practice, it works like this: a third party makes an offer to buy 100% of the company. The majority shareholders vote to accept. Once the drag-along threshold is met, every other shareholder is obligated to transfer their shares to the buyer at the same price per share and on the same terms. No holdouts. No protracted negotiations with individuals who own 2% of the company.
For investors, drag-along rights are close to non-negotiable. They’re essential for a clean exit — which is, after all, how most VC investments return capital. A buyer paying a premium for the whole company isn’t going to accept a structure where a disgruntled minority shareholder can block the deal.
What Are Tag-Along Rights?
Tag-along rights work in the opposite direction. They protect minority shareholders by giving them the right to participate in a sale on the same terms as the majority.
Here’s the scenario: a majority shareholder receives an offer to sell their stake to a third party. Without tag-along rights, the minority shareholders could be left behind — holding shares in a company now controlled by a stranger, with no liquidity and no say in the deal. Tag-along rights prevent this by requiring the selling majority shareholder to procure that the buyer also purchases the minority shareholders’ shares, on the same terms.
For founders, tag-along rights are a critical protection. In the early stages, you’re likely the majority shareholder. But as you raise capital, your stake dilutes. By Series B or C, your investors may collectively hold a majority. If they decide to sell their stake to a new investor or a strategic acquirer, tag-along rights ensure you can join the sale rather than being stuck with an illiquid minority position in a company you no longer control.
They’re Contractual, Not Statutory
This is an important point that trips people up. Drag-along and tag-along rights are not automatic under Australian law. The Corporations Act 2001 (Cth) doesn’t provide for them. They exist only because the parties agree to include them in a shareholders agreement or, less commonly, in the company’s constitution.
That means the specifics — the trigger thresholds, notice requirements, valuation mechanisms, and protections — are entirely negotiable. And the details matter enormously.
A drag-along clause that triggers at 51% gives a very different result than one that triggers at 75%. A tag-along that only applies to ordinary shares but not preference shares creates a gap that can bite you later. A drag-along with no minimum price floor could, in theory, be used to force a sale at a fraction of fair value.
This is where the real negotiation happens, and where generic “customary provisions” language in a term sheet deserves close scrutiny.
Key Negotiating Points
Trigger Threshold
The percentage required to activate a drag-along is the single most important variable. Common thresholds range from 51% to 75%. Founders should push for a higher threshold — 75% is better than 51% if you want to retain meaningful influence over exit timing. Investors will push lower for maximum flexibility.
Minimum Price or Valuation Floor
Some drag-along clauses include a minimum price per share, or a requirement that the offer price represents a minimum return multiple. This protects minority shareholders from being dragged into a sale at a price that doesn’t reflect the company’s value — a real risk in distressed situations or where the majority’s interests diverge from the minority’s.
The 2013 New South Wales Supreme Court case William McCausland v Surfing Hardware International Holdings Pty Ltd is a cautionary tale. The founder alleged his shares were sold via a drag-along at roughly half their actual value. The litigation ran for years and the judgment exceeded 400 pages. A properly drafted minimum price floor might have avoided the dispute entirely.
Notice Requirements
Drag-along and tag-along clauses should specify how much notice must be given, what information the notice must contain (buyer identity, price, terms, settlement date), and what timeframes apply for the minority to respond. Vague notice provisions create uncertainty and potential for disputes.
Same Terms Protection
Both drag-along and tag-along clauses should require that all shareholders sell on the same terms and conditions. Watch for carve-outs. If the majority negotiates side arrangements — management retention packages, consulting agreements, earnouts — that aren’t available to the minority, the “same terms” protection becomes hollow.
Who Bears the Transaction Costs?
A drag-along sale may require legal, accounting, and advisory work. The agreement should be clear about who pays. Minority shareholders forced to participate in a sale shouldn’t bear disproportionate transaction costs.
Warranties and Indemnities
Buyers in M&A transactions typically require sellers to give warranties about the company and indemnities for breaches. This creates a practical problem in drag-along situations: a minority shareholder being compelled to sell may not have the information needed to give those warranties, and may not want the indemnity exposure.
Well-drafted drag-along clauses address this by limiting the minority’s warranty obligations to fundamental warranties only — essentially, that they own their shares and have authority to sell them — rather than requiring them to warrant the company’s financial position or legal compliance.
Application Across Share Classes
If your company has multiple share classes — ordinary shares and one or more series of preference shares — the drag-along and tag-along provisions need to address how they interact with the preference stack. Does the drag-along apply across all classes? Does the liquidation preference get honoured in a drag-along sale, or are all shares treated equally? These questions have significant economic consequences and are frequently under-negotiated.
The Oppression Backstop
While drag-along rights are contractual, they don’t operate in a vacuum. Section 232 of the Corporations Act allows a shareholder to apply to the court for relief if the company’s affairs are being conducted in a manner that is oppressive, unfairly prejudicial, or unfairly discriminatory.
If a majority shareholder uses a drag-along right in bad faith — for example, to force a fire-sale to a related party at a fraction of fair value — the minority shareholder may have a statutory remedy even if the contractual mechanism was technically followed. Courts have shown willingness to look beyond the letter of the agreement where the conduct is oppressive.
This is a backstop, not a strategy. Relying on oppression proceedings is expensive, slow, and uncertain. Far better to negotiate proper protections into the agreement from the outset.
Practical Tips for Founders
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Read the clause, not just the term sheet. “Customary drag and tag provisions” is not a definition. The actual drafting determines your rights.
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Push for a higher drag-along threshold. 75% gives you more protection than 51%. If you’re diluting below 25%, negotiate hard on other protections.
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Insist on a minimum price floor. This is the single best protection against being dragged into a below-value sale.
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Limit your warranty exposure. In a drag-along sale, you should only warrant title to your shares — not the company’s financials or operations.
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Include tag-along rights from day one. Don’t assume you’ll always be the majority. Your tag-along rights are your insurance policy for when you’re not.
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Consider the preference stack. If investors hold preference shares with a liquidation preference, make sure the drag-along clause doesn’t allow a sale price that returns capital to preference holders while leaving ordinary shareholders with nothing.
The Bottom Line
Drag-along and tag-along rights are standard features of any well-drafted shareholders agreement. They serve important functions — enabling clean exits and protecting minority shareholders from being stranded. But the defaults aren’t always fair, and the details aren’t always “customary” in the way the term sheet implies.
If you’re negotiating a shareholders agreement and want to make sure these provisions work for you — not just for the other side — get in touch.
