Venture Capital Term Sheet: Drag-Along Rights
What are Drag-Along Rights?The primary purpose of drag-along rights are to ensure that the investor's shares won't be held hostage in the event of a favorable acquisition or merger event. Drag-along rights permit the holder of the rights to force the other shareholders to sell their shares if there is a third-party offer for the purchase of company that has been approved by a certain percentage of the shareholders - usually a majority or a supermajority such as 70% or 80%. The reason this right is important to investors is that many acquirers will not purchase a company unless they are able to acquire all outstanding stock of the company. If a few shareholders hold out of approving the transaction, the drag along rights will permit the investor to force a sale by the hold-outs.
Will the deal include a Drag-Along provision?Percentage of Deals that include Drag-Along provisions:
Series A 48%
Series B 46%
Series C 42%
Series D 42%
Source: Private Company Financing Report, Cooley Godward Kronish LLP, April 2006 (based on financing transactions from 2004 and 2005)
What is important about a Drag-Along Provisions?In most cases, a drag-along provision is important to the founders of a company much as it is to the investors. However, the reason where motives may differ is where the investors may trigger the drag-along rights over the founders. For instance, if the investors own 75% of the stock of the company and the drag-along threshold is set at 75%, then the investors effectively can use these rights over the founders. Be certain that the thresholds are such that the founders are protected, in the event this is important to your team in the event of a future exit event.