How to Cover a Member’s Death in an LLC Operating Agreement
The death of an LLC member can create legal, financial, and operational challenges if the Operating Agreement doesn’t clearly outline what happens...
7 min read
When an LLC owner decides to sell their interest in the company, it can create challenges for both majority and minority members. What happens if a majority owner wants to sell their stake but minority owners want to stay? Or what if minority owners fear being left behind with a new, unknown majority owner?
This is where tag-along and drag-along rights come into play. These provisions—commonly included in an LLC Operating Agreement—help balance the rights of majority and minority members when an ownership sale occurs.
- Tag-along rights protect minority members by allowing them to sell their shares alongside a majority owner.
- Drag-along rights protect majority owners by requiring minority members to participate in a full business sale.
Clearly defining these rights in an LLC Operating Agreement helps prevent disputes, ensure fair treatment of all members, and create a smoother exit process when ownership changes occur.
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What Are Tag-Along and Drag-Along Rights?
Tag-Along Rights: Protecting Minority Members
Tag-along rights (sometimes called "co-sale rights") ensure that if a majority owner sells their interest, minority owners have the option to join the sale under the same terms and conditions.
Purpose of Tag-Along Rights:
- Prevents minority owners from being left behind with an unfamiliar or potentially unfavorable new majority owner.
- Ensures equal exit opportunities by allowing all members to cash out under the same deal.
- Protects passive investors or smaller members from being forced into a new ownership structure they didn’t agree to.
Example Scenario:
"An LLC has three members: Alex (70%), Jordan (15%), and Taylor (15%). Alex finds a buyer who wants to purchase their 70% stake. Under a tag-along provision, Jordan and Taylor can choose to sell their shares at the same price and terms as Alex, ensuring they are not left in a weakened position with a new controlling owner."
Key Considerations for Tag-Along Rights:
- Thresholds: Usually apply when a majority owner sells more than 50% of their stake.
- Notice Period: Minority owners typically must receive written notice and have a set period (e.g., 30 days) to decide if they want to participate.
- Exclusions: Transfers to family members or existing members may be excluded from tag-along rights.
Drag-Along Rights: Protecting Majority Owners
Drag-along rights force minority members to sell their shares if a majority of members agree to sell the business. These provisions ensure that buyers can acquire 100% of the LLC, rather than being stuck with holdout members who refuse to sell.
Purpose of Drag-Along Rights:
- Prevents minority owners from blocking a sale that benefits the majority.
- Ensures clean ownership transfers for buyers who want full control of the LLC.
- Simplifies mergers, acquisitions, or third-party buyouts.
Example Scenario:
"An LLC has five members, with a majority group (owning 80%) receiving a lucrative acquisition offer. One member, who owns 10%, refuses to sell. Because of the drag-along clause, the holdout member is legally required to sell their stake at the agreed-upon terms, allowing the deal to proceed."
Key Considerations for Drag-Along Rights:
- Majority Approval: The Operating Agreement should specify what percentage (e.g., 66% or 75%) is needed to trigger drag-along rights.
- Fair Valuation: Drag-along provisions should ensure minority members receive the same terms as the majority.
- Legal Protections: If not carefully structured, drag-along rights can lead to disputes over forced sales and valuation fairness.
How These Rights Are Structured in an LLC Operating Agreement
Tag-along and drag-along rights must be clearly defined in an LLC Operating Agreement to avoid ambiguity and disputes. Below are key elements to consider when drafting these provisions.
1. Defining When Tag-Along and Drag-Along Rights Apply
Not every transfer of ownership will trigger these rights. The Operating Agreement should specify:
- Ownership thresholds – Tag-along rights may apply only if a majority owner sells more than 50% of their interest, while drag-along rights might require at least 66%-75% approval from voting members.
- Types of sales covered – These rights typically apply to third-party sales, not transfers to family members, estate planning transactions, or internal buyouts.
- Exceptions and carve-outs – Some agreements exclude tag-along rights for sales below a certain value threshold or allow drag-along sales only if the deal meets a minimum price per unit.
Example Scenario:
"An LLC agreement states that drag-along rights apply only if members holding at least 75% of ownership approve the sale. When an acquisition offer comes in, the largest member holding 60% cannot force the minority members to sell unless they gain support from an additional 15% of the ownership group."
2. Approval and Voting Requirements
The Operating Agreement should specify how members approve sales and enforce these rights.
- Tag-along rights may require only a notification process, giving minority members the option to sell.
- Drag-along rights typically require a supermajority (66%-75%) vote to protect minority members from being unfairly forced into a sale.
- Member notification procedures should outline how much time minority members have to exercise their tag-along rights or prepare for a drag-along sale.
Example Voting Breakdown:
| Decision Type | Simple Majority (51%) | Supermajority (66%-75%) | Unanimous Consent (100%) |
|---|---|---|---|
| Triggering drag-along rights | ❌ | ✅ | ❌ |
| Exercising tag-along rights | ✅ | ❌ | ❌ |
| Amending tag-along/drag-along provisions | ❌ | ✅ | ❌ |
This structure ensures balance between the interests of majority and minority members while keeping decision-making clear.
3. Sale Terms and Conditions
Once triggered, tag-along and drag-along rights must include clear terms regarding:
- Price Matching – Minority members must receive the same price per unit and sale terms as the majority.
- Payment Structures – The agreement should specify whether payments will be cash, stock, or another form of compensation.
- Timeframe for Execution – Members must have a clear deadline to comply with the sale terms (e.g., 30-60 days).
Example Scenario:
"An LLC receives a buyout offer where the acquirer is paying 80% in cash and 20% in stock. Minority members exercising their tag-along rights must receive the exact same payment structure to ensure fairness."
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Key Benefits and Risks of Tag-Along & Drag-Along Rights
Benefits of Tag-Along Rights
- Protects minority members from being left behind with an unfavorable new owner.
- Ensures equal sale terms for all members.
- Creates liquidity opportunities for passive investors.
Risks of Tag-Along Rights
- May complicate negotiations, as buyers might not want to purchase additional minority stakes.
- Could reduce the majority owner’s ability to sell quickly if minority members delay approvals.
Benefits of Drag-Along Rights
- Ensures a smooth sale process for majority owners.
- Helps attract buyers who want full ownership control.
- Prevents holdout members from blocking an acquisition.
Risks of Drag-Along Rights
- Minority members may feel forced into a sale against their will.
- Risk of unfair valuations if the agreement does not define a fair price determination method.
- Potential for legal disputes if drag-along rights are vaguely worded.
Sample Tag-Along and Drag-Along Provisions
When drafting an LLC Operating Agreement, it’s essential to use clear, enforceable language to define tag-along and drag-along rights. Below are sample provisions that can be customized based on your LLC’s specific needs.
Sample Tag-Along Rights Clause
This clause protects minority members by allowing them to join in on a sale when a majority owner sells their interest.
Example Language:
"If any Member or group of Members holding at least [X]% of the Membership Interests in the Company proposes to sell their Interests to a third party, then each remaining Member (the ‘Tag-Along Members’) shall have the right, but not the obligation, to sell their proportional share of Interests at the same price and under the same terms as the selling Members. The selling Members shall provide written notice to all Tag-Along Members at least [X] days before the proposed sale, specifying the material terms of the transaction. Each Tag-Along Member shall have [X] days from receipt of such notice to elect, in writing, to participate in the sale. Failure to respond within the notice period shall be deemed a waiver of such rights."
Sample Drag-Along Rights Clause
This clause ensures that if the majority agrees to sell the LLC, minority members must participate in the sale under the same terms.
Example Language:
"If Members holding at least [X]% of the Membership Interests in the Company (the ‘Approving Members’) approve the sale of the Company or substantially all of its assets, then all Members, including those who did not approve the sale, shall be required to sell their Interests on the same terms as the Approving Members. The Approving Members shall provide written notice to all Members specifying the terms of the transaction. Each Member agrees to execute any necessary documents to facilitate the sale and shall not take any action that would hinder or delay the transaction."
Additional Considerations for Customization
To make these provisions effective, consider including:
- Thresholds for triggering rights (e.g., drag-along rights apply only if 75% of ownership approves).
- Timeframes for response (e.g., minority members have 30 days to exercise tag-along rights).
- Minimum price protections to prevent forced sales at an unreasonably low valuation.
Common Pitfalls & How to Avoid Them
Even with well-drafted provisions, misunderstandings or legal disputes can arise. Here’s how to avoid common mistakes:
1. Failing to Clearly Define the Rights
Ambiguous language can create uncertainty about when rights apply and how members must comply.
Solution: Clearly specify thresholds, notice periods, and exclusions in the Operating Agreement.
2. Not Establishing a Fair Valuation Method
Drag-along provisions can be abused if a majority owner forces a sale at an unfair price.
Solution: Require a third-party valuation if any member disputes the sale price.
3. Overlooking Notification and Consent Procedures
If minority members don’t receive adequate notice, they may challenge the sale.
Solution: Ensure tag-along and drag-along clauses include written notification procedures and clear deadlines for responses.
Conclusion
Tag-along and drag-along rights help balance majority and minority ownership interests in an LLC. By clearly defining these rights in an LLC Operating Agreement, members can ensure smoother transactions and prevent legal disputes.
Key Takeaways:
- Tag-along rights protect minority owners by allowing them to sell their shares on the same terms as a majority seller.
- Drag-along rights ensure that majority owners can sell the LLC without minority holdouts blocking the transaction.
- Proper structuring prevents disputes and ensures fairness for all members.
If you’re structuring an LLC and want to include these protections, check out our customizable LLC Operating Agreement template to simplify the process.
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