Drag-Along Rights

Drag-Along Rights Critical Since Omnicare’s Invalidation Of Lockups

Abstracted from: Drag-Along Rights: Recent Case Affects Planning For Acquisitions

By: William Simmons

Testa Hurwitz & Thibeault, Boston, MA

Venture Update - Fall 2003, Pgs. 1-2, 8

Providing for private investors' protection. Attaching drag-along provisions to a shareholders' agreement protects private equity investors when they are ready to sell the investment. A Delaware Supreme Court case, which nullified terms designed to protect a negotiated merger, emphasizes the importance of demanding drag-along rights in private equity deals, William Simmons writes. In Omnicare vs. NCS Healthcare Inc., the court held that NCS's particular combination of defensive measures impaired the ability of its directors to exercise proper fiduciary care and prevented the shareholders from being able to reject the transaction. With drag-along rights, shareholders agree in advance to participate in any future sale of the company or its assets if a specified percentage of them or the preferred shareholders approve the deal. In today's precarious capital environment, drag-along rights make the deal more appealing to skittish buyers, who can propose a sale and execute it even if the directors do not approve. Absent such an agreement, the buyer risks having the deal invalidated under Omnicare; with it, the buyer is reasonably assured of the votes necessary to close the deal.

Drafting a deal.

To be valid, drag-along rights must be carefully structured, negotiated simultaneously with the preferred investors' investment, and included in any shareholders' agreement. The rights typically terminate if the company undertakes a public offering. The author lists several points that the drafters should address, such as what percentage or class of shareholders can trigger the rights and whether the company can issue additional stock unless the new shareholders agree to the drag-along. Even when a lockup is not a primary concern, the rights are useful when private equity investors are in the minority or when their interests do not coincide with those of the other shareholders. Questions of price or sale terms may be especially contentious if disparities will raise the proceeds realized by one group of investors.

Abstracted from Venture Update, published by Testa Hurwitz & Thibeault, 125 High Street, Boston, MA 02110

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