What would happen if you form a partnership where you own 80% and your partner owns 20%? You want to sell your interest for a considerable profit but your partner doesn’t want to sell. How can you prevent a minority owner from interfering with your ability to sell?
Enter drag-along rights.
A drag-along provision of an LLC agreement is a negotiated pre-formation exit strategy. A drag-along provision allows the majority member (or group of members) the ability to sell all or most of the company to a third party without interference from minority members.
A drag-along provision can be triggered by an owner (or group of owners) owning at least 51% of the company. The exact percentage is a negotiated term, where the majority owner wants the trigger at or close to 51%, and where the minority members want the trigger much higher to give them more leverage in any buyout.
If triggered, a drag-along provision allows the majority owner to force the minority owner into the sale transaction, regardless of what the minority owner wants. The minority owner is dragged-along for the ride, so to speak, in any such sale transaction.
An example of a drag-along provision in an LLC agreement might look something like this:
If at any time a Member or group of Members owning at least 51% of the outstanding company units (the “Selling Member”), receives a bona fide offer to purchase all outstanding units of the company, (a “Drag-along Sale”), the Selling Member shall have the right to require that each other Member (each, a “Drag-along Member”) participates in such sale in the manner set forth in Article ____ of this agreement; provided, however, that no Drag-along Member shall be required to transfer or sell any of her units if the consideration for the Drag-along Sale is other than cash. Each Drag-along Member shall grant irrevocable proxy to the Selling Member to vote the Drag-along Member’s interest and take whatever steps that might be required to consummate the sale.
Other issues come into play such as whether the Selling Member can require the Drag-along member to make certain representations, or agree to indemnification required by the buyer. Also, what would happen if the buyer requires a strong non-compete provision that would restrict the minority owner from employment? These, and many others, are additional issues that must be addressed.