In order to prevent a situation where, following an investment, the founders jump ship and sell their shares to a third party investor, most venture financings will include a co-sale right. The co-sale right gives the investor the right to sell its shares on the same terms as the investors - usually on a pro-rata basis of its total ownership percentage in relation to the total sale.
How do co-sale rights work?
Co-sale rights, sometimes called tag-along rights, are the right to participate in any pre-IPO sale by the founders in proportion to the relative number of shares owned by the founders and the investors. In a company where a founder or founders controls a majority of the company, the investors will often request co-sale rights. As a practical matter, the co-sale right will limit the incentive and ability of the founders to dispose of a significant portion of their holdings in the company prior to the IPO. However, since the opportunities for separate liquidity for founders generally tend to be limited, co-sale rights are not generally viewed to be significantly disadvantageous to founders in most situations, and are less likely to be negotiated than other more meaningful terms, such as vesting on founders' shares.
When will investors use co-sale rights?
Investors may wish to participate in any pre-IPO stock sale by the founders. Co-sale rights, if exercised, will result in less money to you upon a private stock sale, and the notice and other requirements of a co-sale right may impede a sale. Nevertheless, because the investors want to use equity to direct the Company's management towards a long-term return rather than an early cash-out, they are likely to insist upon a co-sale right.
How common are co-sale rights in a venture capital financing?
Co-sale rights are common in venture investments and typically will offer exceptions for certain types of transfers, such as for small amounts of stock, sales or transfers to family members, or sales in the event of termination of employment or death of the founders. In addition, the co-sale rights will often be accompanied by a right of first refusal for the investors. With a right of first refusal, founders will be restricted from selling their shares to any third party without first offering the shares to the company and/or the investors. The shares will be offered on the same terms as given to the proposed third party purchaser.
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