Tag-Along Right

What is a tag-along right?

Tag-along right (Mitverkaufsrecht) describes the contractual right of a shareholder to sell their own shares on the same terms when a co-shareholder sells shares to a third party. The selling shareholder may transfer their shares only if the purchaser also takes over the shares of the entitled holders who exercise their right. Synonyms in use are right to sell alongside (Mitveräußerungsrecht), tag-along clause and, in US contracts, co-sale right; the plural, tag-along rights, refers to the same right.

The right protects minority shareholders, above all investors and business angels. If founders or a principal shareholder sell their holding, the minority should not be left behind with a new majority shareholder it did not choose. At the same time, the right secures it a share of the premium that a purchaser pays for control. It is agreed in the shareholders' agreement, the contract between the shareholders alongside the articles of association, which is concluded in a financing round. There it usually stands next to the right of first refusal (Vorerwerbsrecht), that is, the right to buy shares offered for sale oneself, and next to the drag-along obligation (Mitveräußerungspflicht). In the US market, the right of first refusal and the tag-along right are often set out in a separate contract, the co-sale agreement.

Trigger and scope of the tag-along right

Proportionate and full tag-along right

With a proportionate tag-along right (pro rata tag-along), the entitled holders participate, in proportion to their holdings, in the quantity that the purchaser wants to buy. If this quantity remains fixed, the original seller sells correspondingly less. The clause must therefore regulate whether the purchaser takes only the originally agreed quantity or must take additional shares.

Formula: tag-along quantity of a shareholder = quantity taken by the purchaser × own shares ÷ shares of all shareholders willing to sell, including the original seller

With a full tag-along right (full tag-along), the entitled holders may sell all their shares. This form is as a rule tied to a change of control, that is, to a sale through which the purchaser reaches more than half of the shares or another agreed control threshold. For the purchaser this means: anyone who wants to take control must be prepared also to take over the remaining shareholders.

Transfers covered and exceptions

A tag-along right is common for sales by the founders, and in some cases for sales by any shareholder. The clause should also cover indirect transfers: if a founder holds their shares through a holding GmbH, the sale of the holding must not circumvent the right. Permitted transfers are usually excluded. These include transfers to a shareholder's own, fully controlled holding company, to family members in the context of succession and between funds of the same management group. Also excluded are retransfers under the leaver rules, which govern the departure of founders, and transfers made under the drag-along obligation. Some agreements also exclude small sales up to a de minimis threshold.

Procedure and enforcement of the tag-along right

If a shareholder wants to sell, they must notify the co-shareholders of the sale in writing, stating the purchaser, the number of shares, the price and the essential terms. From receipt, an exercise period runs, often two to four weeks. Entitled holders who want to sell alongside declare this within the period. The sale must then be completed within a set period and on terms that are not more favourable to the seller than those notified. If that fails, the procedure begins afresh with any new attempt.

If a right of first refusal also exists, the agreement sets the order. It is usual for the co-shareholders to decide first whether to buy the shares themselves. Only to the extent that they waive this can they exercise their tag-along right against the third party.

Effect against the purchaser

The tag-along right is a contractual claim between the shareholders. A transfer in breach of the right would, taken by itself, be valid, and the seller would owe only damages. The right is therefore secured through the articles of association. If a restriction on transfer (Vinkulierung) under Section 15(5) of the German Limited Liability Companies Act (GmbHG) makes every transfer dependent on consent, the shareholders undertake to give this consent only if the tag-along procedure has been followed. Without consent, the assignment remains ineffective. Contractual penalties are often added.

Economic effect for founders, investors and purchasers

For the minority, the right is above all an instrument of equal treatment. If a purchaser pays a premium for the majority, the control premium, the entitled holders receive the same price per share. For founders, the right restricts the possibility of selling part of their shares outside an exit. In such a secondary sale, in which existing shares change hands and no new money flows into the company, the founder's quantity is reduced if investors sell alongside.

Whether the tag-along proceeds are distributed according to the agreed ranking depends on the definition of the exit event. If it covers the sale of the majority of the shares, the liquidation preference applies here too, and the proceeds are not simply distributed per share. The sale of the business by the company itself is generally not covered. In an asset deal, no shares are transferred and the tag-along right comes to nothing. Protection is then offered by the exit definition in the distribution of proceeds and by the investors' consent reservations (protective provisions).

Worked example: tag-along on the sale of the founder majority

The share capital of a GmbH consists of 100,000 shares with a nominal value of EUR 1 each. The founder holds 55,000, an investor 30,000 and a business angel 15,000 shares. The last financing round took place at EUR 120 per share. A strategic purchaser offers the founder EUR 180 per share for the founder's 55,000 shares, together EUR 9.9 million. With the acquisition, the purchaser would obtain the majority.

• Full tag-along right because of the change of control: the investor can demand 30,000 × EUR 180 = EUR 5.4 million, the business angel 15,000 × EUR 180 = EUR 2.7 million. The purchaser would have to raise 100,000 × EUR 180 = EUR 18 million.
• Proportionate tag-along right if the purchaser stays at 55,000 shares: all three sell in proportion to their holdings. Founder 55% × 55,000 = 30,250, investor 30% × 55,000 = 16,500, business angel 15% × 55,000 = 8,250 shares.
• Proceeds: founder 30,250 × EUR 180 = EUR 5,445,000, investor 16,500 × EUR 180 = EUR 2,970,000, business angel 8,250 × EUR 180 = EUR 1,485,000, together EUR 9.9 million.
• Premium over the last round: the investor receives 180 minus 120 = EUR 60 more per share, so EUR 990,000 on 16,500 shares.
• Holdings afterwards: purchaser 55,000, founder 24,750, investor 13,500, business angel 6,750 shares.

The example shows both sides. The purchaser reaches its majority even from a mix of sellers, and the minority takes part in the higher price. The founder realises only EUR 5.445 million instead of EUR 9.9 million. With 24.75%, the founder also loses the blocking minority with which a shareholder holding more than 25% of the votes can prevent amendments to the articles of association alone (see veto rights).

Distinctions: tag-along, drag-along, right of first refusal and mandatory offer

• Drag-along rights: with the drag-along obligation, the initiative comes from the majority, which wants to enforce a sale of all shares. The tag-along right works in the opposite direction and is a right, not an obligation.
• Right of first refusal: the right to acquire the shares offered for sale oneself. The tag-along right, by contrast, concerns one's own participation in the sale to the third party.
• Co-sale agreement: in the US market, the stand-alone contract that bundles the right of first refusal and the tag-along right. In Germany both rights appear in the shareholders' agreement.
• Mandatory offer: anyone who obtains control of a listed stock corporation, that is, at least 30% of the voting rights, must make an offer to all remaining shareholders under Section 35 of the German Securities Acquisition and Takeover Act (WpÜG). For the GmbH there is no such statutory rule; the tag-along right closes this gap by contract.

Common mistakes

• Indirect transfers not covered. If the right applies only to the shares themselves, it can be circumvented by selling a holding company.
• No reduction rule. Without a rule on allocation where the quantity taken is fixed, it is unclear whether the purchaser must buy more or the seller may sell less.
• Unclear order with the right of first refusal. If the periods of the two rights overlap, an entitled holder may want to buy and sell alongside at the same time.
• Exceptions too narrow. If there are no exceptions for holdings, succession and leaver retransfers, every internal restructuring triggers a formal procedure.
• No safeguard in the articles of association. Without a restriction on transfer, the shareholder who was passed over is left only with a claim for damages, the amount of which is hard to prove.

Frequently asked questions

What is the difference between tag-along and drag-along?

Tag-along is a right of the minority; drag-along is an obligation that an agreed majority can trigger. With tag-along, each entitled holder decides for themselves whether to join a co-shareholder's sale. With drag-along, the remaining shareholders must, at the majority's request, sell alongside on the same terms.

When does a tag-along right apply?

As soon as a covered shareholder wants to sell shares to a third party and no agreed exception applies. Some agreements limit the right to sales by the founders or to sales above a minimum quantity.

How long do entitled holders have to exercise the tag-along right?

Often two to four weeks from receipt of the sale notice. Anyone who lets the period lapse loses the right for that sale. Shorter periods speed up the process but presuppose that the notice contains all essential terms.

What happens if the purchaser does not want to take additional shares?

Then the seller may sell only a correspondingly reduced quantity, or must take over the entitled holders' shares themselves on the notified terms. Which variant applies is determined by the clause.

Does the tag-along right also apply to an asset deal?

As a rule not, because no shares are sold. The proceeds of such a sale are captured by the distribution of proceeds if it defines the sale of essential assets as an exit. The decision on the sale itself is usually subject to the investors' catalogue of consent requirements.

Can employees with virtual shares sell alongside?

No. The tag-along right presupposes company shares. Virtual shares are contractual payment claims against the company, and their treatment in a sale is governed solely by the participation plan.

The Roemer Capital view

Roemer Capital encounters tag-along rights in mandates in two situations. If founders sell part of their shares to the new investor as part of a financing round, Roemer Capital clarifies in advance with the existing investors whether they will sell alongside or waive the right. This way a reduction does not first come to light at the notary appointment, and the round planning stays reliable.

On the sale of a majority, Roemer Capital calculates for each shareholder what they would receive on a full and on a proportionate tag-along sale. The notice and exercise periods are aligned with the purchaser's timetable. The interpretation of the clause in the individual case is handled by the client's law firm.