Deal Terms
What are drag-along rights?
Quick Answer
Drag-along rights allow majority shareholders (typically a combination of founders and investors) to force minority shareholders to join in the sale of a company, ensuring a clean exit without holdouts blocking the deal.
Detailed Answer
Drag-along rights are a standard term sheet provision that prevents minority shareholders from blocking a company sale that the majority approves.
How it works: 1. A buyer offers to acquire the company 2. If shareholders holding a specified majority (typically 50-67% of all shares, or a majority of each class) approve the sale 3. All remaining shareholders are "dragged along" — they must sell their shares on the same terms
Why drag-along exists: - **Buyer protection** — Acquirers want 100% of shares, not 85%. Holdouts can kill deals. - **Efficiency** — Prevents small shareholders from extracting premium prices or blocking transactions.
Key negotiation points: - **Threshold** — What percentage triggers drag-along? Higher thresholds protect minority holders. - **Price floor** — Some drag-along provisions require the sale price to exceed a minimum (e.g., 2x the liquidation preference) to prevent investors from dragging founders into a bad sale. - **Carve-outs** — Some provisions exempt founders or key employees from being dragged below certain prices.
Related concept: **Tag-along rights** are the opposite — they let minority shareholders JOIN a sale on the same terms, protecting them from being left behind.
Related Questions
What is a SAFE (Simple Agreement for Future Equity)?
A SAFE is an investment contract created by Y Combinator where an investor provides capital to a startup in exchange for the right to receive equity in a future priced round, with terms like a valuation cap and/or discount rate.
What is a term sheet?
A term sheet is a non-binding document that outlines the key terms and conditions of a proposed investment, including valuation, investment amount, board seats, liquidation preferences, and protective provisions.
What is a liquidation preference?
A liquidation preference gives preferred shareholders (investors) the right to receive their investment back before common shareholders in an exit. The standard is 1x non-participating, meaning investors get back their investment amount or convert to common stock — whichever is higher.
What is a convertible note?
A convertible note is a short-term debt instrument that converts into equity at the next priced round, typically with a valuation cap, discount rate, interest rate (2-8%), and maturity date (12-24 months).
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