Although common, this provision is problematic for drags. Drags are usually provisions of the articles of association, is an agreement among the shareholders of the company. A drag therefore usually only binds shareholders – so while it can give shareholders obligations in respect of the options that they also hold, a drag cannot compel anyone to sell their options if they are not also a shareholder. On exercise of their options each of these optionholders will become a shareholder – but that takes place after the drag sale, so they are not compelled to sell.
Usually the buyer has to make an offer to each optionholder, at the same price per share (less their exercise price), and the deal will not go ahead until they have all accepted. This could be by letter, or by having the optionholders sign up to the share purchase agreement itself. Either way, completing a sale on this basis in a timely fashion will rely on all of the optionholders being easily contactable and co-operative.
Having already adopted the option
scheme before they created their drag, LotsaOptions therefore ensured that the drag would work in their situation. Their drag contained a clause that forced an immediate sale of any shares issued following the exercise of any option that had been outstanding when the drag was exercised, on the same terms as the drag sale.
This worked perfectly – upon exercise of their options each optionholder would become subject to the articles, which
would immediately compel him to sell. By taking the time to fit their drag to their situation, the management and investors in LotsaOptions saved themselves considerable time and fees when they conducted their successful exit.
Conclusion A well-drafted drag is a crucial cog in the machine that is an entrepreneur’s company.
Entrepreneurs should take
care to ensure that their drag rights involve a minimal administrative burden, address the main circumstances in which the company may find itself and retain some flexibility in case emergencies occur and the drag cannot be changed in response to them.
Just as importantly, when other parts of the machine are about to change entrepreneurs should also look at this cog – how does this new option scheme, for example, fit with the drag? Making last-minute changes to drags can be problematic and expensive, and sometimes not possible. Keeping them up to date with the changing shape of the company and its shareholder base is the best way to make the machine runsmoothly.
David Willbe is a lawyer in the Corporate Group, in the London office of Crowell & Moring, an international law firm.
Next month’s article will look at potential problems with granting equity to employees, and how to avoid them.
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