[Startup Investment] Drag Along Rights - Yes
'Drag along rights' actually sounds scary. But based on statistics you'll probably see this in your early investment contracts for your startup. But is it common / market?
Yes
Prevalence of Drag-Along Rights
The Venture Beacon report by Aumni, a comprehensive analysis of investment contracts up to the end of 2023, reveals that 97.97% of the agreements they reviewed include drag-along rights. <source>This statistic highlights the significance attributed to these provisions by investors, aiming to facilitate exit mechanisms without obstruction from minority shareholders.
Drag-along rights enable majority shareholders to compel minority shareholders to participate in the sale of a company, ensuring that a sale can proceed without unanimous agreement. This setup is designed to streamline the acquisition process and protect the investments of major stakeholders.
Rationale Behind Drag-Along Rights
The rationale for the widespread inclusion of drag-along rights in startup investment contracts can be summarized as follows:
- Facilitation of Sale Process: These provisions make startups more appealing to potential acquirers by allowing for the acquisition of complete ownership without individual negotiations with numerous smaller shareholders.
- Protection of Majority Shareholder Interests: Investors, particularly those providing substantial capital, leverage drag-along rights to secure their exit strategy, aiming to ensure a return on their investment.
- Equilibrium in Negotiation Power: Although drag-along rights may appear to favor majority shareholders, they establish clear conditions under which minority shareholders may be required to sell, providing a predictable framework for all parties involved.
Additional Data and Observations
- Drag along and tag along rights are common provisions in equity'>private equity (PE)/venture capital (VC) and corporate joint venture (JV) transaction documentation. - Lexisnexis
- Flyer One Ventures If you own a majority stake in a startup, drag-along rights allow you to compel minority shareholders to sell their shares when you sell yours. It ensures unanimous agreement and prevents obstruction <source>
- AngelList's learning center asserts that drag-along rights play an essential role in avoiding deadlock situations that can impede sales, illustrating the practical need for such provisions in venture deals.<source>
- FasterCapital emphasizes the utility of drag-along rights in investor agreements, noting their significance in ensuring that venture capitalists can execute exit strategies efficiently, thereby safeguarding their investments. <source>
- TykeInvest provides a balanced examination of drag-along rights, highlighting their impact on both investors and founders, and reinforcing the notion that these clauses are fundamental to the structuring of equitable sale agreements.<source>
Conclusion
Is having a drag along rights provision ok? Depends on the situation and you should consult professionals to make the right decision for your startup. But know that vast majority of startup investment contracts have them.