A drag along provision (known, more benignly, as a bring along provision) is a common mechanism in investment documents. It allows the holders of a certain majority of a company’s shares to initiate and force a sale of the company (or substantially all of its assets), and prevents minority shareholders from blocking an attractive exit, or worse leveraging the need for their consent to close a deal.

The Israeli Companies Law (1999) provides a statutory drag along provision, which dictates that if an offer to buy all the shares of a company is accepted by the holders of at least 80% of the shares of the company, then within 3 months all the shareholders will be compelled to sell their shares. The caveat is that the objecting shareholders have a specific right to challenge the sale in court.

However, most Israeli hi-tech companies draft their own bring along provisions, turned off by the high threshold and waiting period in the law. Although the law clearly provides that a company can deviate from the threshold (if agreed in its Articles of Association), it remains unclear whether the 3 month waiting period may be amended.

While drag along provisions are helpful in avoiding the hassle and mitigating the risks associated with uncooperative minority shareholders or minority shareholders that are difficult to locate or non-responsive, if you are a minority shareholder, you do not want to be dragged, you want to sell on your terms.

Here are five tips to help the minority shareholder ensure the drag along mechanism works for him/her when negotiating his/her investment in the company:

  1. Majority Threshold: Ensure a high threshold to trigger the drag along, the more shareholders that agree to the sale, the more likely it will be on attractive terms.
  1. Minimum Proceeds: Ensure that the drag along is triggered only if the sale of the company exceeds a minimum valuation. This would prevent the entrepreneurs from selling the company on the cheap; after all they probably have not invested much capital in the company and may be interested in simply exiting and moving on. You would want to guarantee a return of your investment (or your agreed liquidation preference ) as a bare minimum.
  1. Representations: Ensure that in the exit agreement you will not be required to make representations or warranties on behalf of the company (i.e. statements regarding ownership of its intellectual property, litigation, compliance with law etc), and your
    liability will be restricted to representations and warranties with respect to your authority, ownership and the ability to convey title to your shares.
  1. Liability: Ensure that your liability in the exit agreement will be capped at the amount of consideration you receive upon the sale, and that you will not be responsible for the actions of the other shareholders (i.e. several and not joint liability).
  1. Consideration: Ensure that all shareholders will receive the same form of consideration (preferably cash) and price per share (unless the company’s Articles of Association provide a different liquidation preference for more senior shares). It may also be worth addressing future earn-out payments. When buying a company the purchaser often incentives management to stay on and continue running the company by way of future performance payments, however this tool can also be used to discriminate against investors.

Naturally, there will be tension in these negotiations with majority and minority shareholders having opposing interests; however a smartly negotiated and drafted drag along provision will guarantee that in the future you will not be dragged unwillingly.