The Dark Side of Drag-Along/Tag-Along Rights

  March 02 2007

Michael Arrington talks about the sale of FilmLoop. Due to drag-along rights, ComVentures was able to force an unfavorable sale to another company in its portfolio - leaving the founders with essentially nothing.

One day, the founders and employees of FilmLoop had a viable company with $3 million in the bank. The next day they had no stock, no job, and no company.

Drag-along rights (and the counterpart, tag-along rights) are fairly standard terms in a stock agreement. Drag-along rights mean you can force the other shareholders to join in the sale of the stock at the same price, terms and conditions. This would normally come into play if someone made an offer for the company but one of the founders decides not to sell - this clause allows the VC to compel the sale. Tag-along rights are the opposite, usually giving a minority shareholder the ability to participate in a sale - if the majority shareholder wants to sell, he can't do so without including the minority shareholder.

I'll get into the details more in a future post, but the typical structure of a VC firm has a big impact on the types of investments they can and do make. A venture capital firm is typically not interested in "cash cows" and instead look for investments where they can exit with a significant return within a 3-5 year window at a significant multiple. In other words, the VC prefers a home run, and in many cases is going to prefer you swinging for the fences and striking out as opposed to getting singles. These rights are usually there to ensure that, if the home run (or triple) is there, they can take advantage.

This is an example of how they can be used in less ethical ways - all the more reason to be careful who you take your money from.


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