Liquidity clause, drag along, tag along: complete guide

A liquidity clause organises the exit of shareholders from a company. It covers three distinct mechanisms: the drag along (forced exit of minority shareholders), the tag along (co-sale right for minority shareholders), and programmed exit provisions (a strategic review meeting, a mandate to an investment bank, or an initial public offering). Well-drafted, it balances minority shareholder protection with majority shareholder liquidity in a shareholders' agreement. Overlord structures your investment vehicle with an agreement that secures the exit of all parties.

You want to open your share capital to co-investors. Or you are setting up your first investment vehicle with a dozen shareholders. In both cases, one question always comes up: how does each party exit the company?

This question is resolved by the liquidity clause in the shareholders' agreement. The term can be misleading. In practice, it refers to three distinct clauses: the drag along, the tag along, and the programmed exit provision.

Vague definitions are everywhere. It is difficult to know what actually applies to your situation. You may be concerned about drafting that is too favourable to one party or another.

This guide clarifies the three mechanisms and shows how to combine them in a balanced agreement. It incorporates the relevant legal references applicable under French law.

What is a liquidity clause in a shareholders' agreement?

A liquidity clause is a provision in the shareholders' agreement that organises the exit of shareholders. It is triggered at an agreed term or upon a specific event.

Legal definition and purpose

This clause appears in the shareholders' agreement and sometimes in the company's articles of association. It sets out the conditions under which shareholders transfer their shares.

Its purpose is straightforward. It prevents a shareholder from remaining locked into a company they cannot exit. It protects the value of their investment.

In a SAS (Societe par Actions Simplifiee), articles L.227-13 to L.227-17 of the French Commercial Code authorise the articles of association to include such clauses. Enforceability is reinforced accordingly. A transfer in breach of a statutory clause is void.

For a SARL (Societe a Responsabilite Limitee), the clause most often appears in an extra-statutory shareholders' agreement. Its violation triggers the contractual liability of the breaching shareholder.

The shareholders' agreement is the preferred framework for these clauses.

Narrow vs broad meaning: why the term is misleading

In private equity practice, the term 'liquidity clause' covers two distinct realities.

In its narrow sense, it refers to the clause that programmes an exit at a defined horizon. This clause may provide for a strategic review meeting among shareholders, a mandate to an investment bank, or an initial public offering.

In its broad sense, it encompasses all clauses that organise an exit. This includes the drag along (forced exit), the tag along (co-sale right), and the programmed exit provision itself.

This ambiguity explains why so many agreements contain provisions that are poorly aligned with the drag along and tag along. The three mechanisms coexist. They do not substitute for one another.

The overall framework covers three distinct mechanisms: drag  along, tag along, and programmed exit.

Drag along vs tag along: key differences

The drag along obliges minority shareholders to sell in the event of a global buyout offer. The tag along allows them to sell on the same terms as the majority shareholder.

The two clauses look similar on the surface but serve opposing interests. French law has confirmed the validity of these co-sale clauses, including through the reform of August 2005.

Drag along: forced exit for minority shareholders

The drag along, or forced co-sale clause, obliges minority shareholders to transfer their shares. It is triggered when a buyer makes an offer to acquire 100% of the share capital.

Without this clause, a reluctant minority shareholder can block the sale. Buyers typically want the entire share capital, not a partial stake.

The drag along serves the majority shareholder's interest. It secures the liquidity of their investment. This clause is systematically requested by investment funds when entering the share capital.

Tag along: co-sale right for minority shareholders

The tag along, or co-sale right clause, works as a mirror mechanism. The minority shareholder has a right, not an obligation.

When the majority shareholder transfers their shares to a third party, the minority shareholder may require that their own shares be sold to the same buyer on identical terms: price, timeline, and warranties.

The tag along protects the minority shareholder against an unwanted change of control. It prevents you from remaining a shareholder with a partner you did not choose.

The drag along serves the majority shareholder's interest in exiting. The tag along protects the minority shareholder from remaining captive.

How the drag along clause works

The drag along clause is triggered when a defined threshold of shareholders accepts a buyout offer. Without this threshold, the clause loses its practical effect.

Trigger threshold and conditions

Standard thresholds are set at 50%, 66%, or 75% of the share capital. The choice depends on the ownership structure and the desired balance.

A 50% threshold facilitates exit: a simple majority is sufficient to pull all shareholders along. A 75% threshold protects minorities: the decision requires broad consensus.

The clause must also specify the reference price. This price typically corresponds to the third-party buyer's offer. You may include a floor price guarantee or an expert determination mechanism in case of disagreement.

A drag along clause without a clear threshold and reference price is unenforceable in practice.

Articles of association or shareholders' agreement: where to insert the clause?

The choice between articles and agreement determines enforceability.

In a SAS, statutory insertion provides the strongest protection. Articles L.227-13 to L.227-17 of the French Commercial Code authorise the articles of association to include forced transfer clauses. A transfer in breach is void.

Inserting the clause in the shareholders' agreement remains valid. Its violation triggers damages without voiding the transfer.

The approval clause, which complements the drag along, follows the same analysis.

For SARLs, the extra-statutory route is the standard. The French Commercial Code provides no equivalent to the SAS provisions.

How the tag along clause works

The tag along clause is exercised when a reference shareholder transfers a significant portion of their shares to a third party. The beneficiary has a right, not an obligation.

Beneficiaries and exercise mechanics

The tag along typically benefits minority shareholders. The clause may name specific shareholders or cover all those holding below a defined threshold.

The exercise mechanics follow four steps: the majority shareholder notifies their intention to sell; the beneficiary has an option period, typically 30 to 60 days; they decide whether to exercise their co-sale right; and the transfer is completed on identical terms.

Identical terms include the price per share, asset and liability warranties, and the payment schedule. Any earn-out provisions apply equally.

Proportional vs full tag along

Two variants exist in practice.

The proportional tag along limits the minority shareholder's exit to their pro-rata share. If the majority shareholder transfers 40% of their shares, the minority may transfer 40% of theirs. This variant protects the minority without blocking a partial transfer.

The full tag along allows a complete exit. As soon as the majority shareholder transfers a single share, the minority may sell their entire stake. This variant is less common and more constraining for the transferor.

The choice between the two shapes the balance of the agreement. The full tag along is significantly more favourable to minority shareholders. The proportional variant offers a middle ground.

The tag along is the natural counterpart of the drag along in a balanced shareholders' agreement.

The liquidity clause in its narrow sense: programmed exit

The liquidity clause in its narrow sense programmes an exit at a defined horizon, typically five to seven years. It provides an automatic trigger mechanism.

This clause responds to a systematic demand from financial investors. Without it, their stake remains theoretical until a buyer appears.

Strategic review meeting (5 to 7 years)

The strategic review clause sets a date at which shareholders meet to examine available exit options. This meeting produces a concerted exit plan.

Three outcomes are typically provided for: a trade sale, a management buyout, or a mandate to an investment bank. Shareholders choose together the most appropriate route.

The clause may also provide for automatic triggering of the drag along if the meeting fails to reach agreement. This articulation secures the investor's effective exit.

Mandate to an investment bank

The clause may directly provide for a sale mandate. At the agreed term, the company mandates an investment bank to find a buyer for 100% of the capital.

This route is demanding but effective. It applies to companies of a certain size, generally from €10 million enterprise value upwards.

The mandate specifies the appointed bank, the duration, the fees, and the conditions for accepting offers.

Initial public offering as a liquidity event

An IPO (Initial Public Offering) is the ultimate liquidity event. The shares become tradeable on a regulated market.

This route remains uncommon. It requires a critical size, proven profitability, and sufficient market appetite. The clause may nonetheless mention it as an alternative to a trade sale.

In its narrow sense, the liquidity clause programmes an exit, whereas the drag along and tag along trigger an exit on a specific event.

Combining the three clauses in a coherent agreement

An agreement that includes drag along, tag along, and a review clause without rigorous coordination becomes unenforceable. The balance depends on the thresholds, prices, and timelines.

Balance between majority and minority shareholders

Article 1844-1 of the French Civil Code prohibits leonine clauses. A clause that entirely deprives a shareholder of the right to profits or losses is void. This limit governs the drafting of exit clauses.

In practice, balance is achieved through symmetry. If the majority shareholder obtains a drag along at 50%, the minority shareholder obtains a full tag along. Coherent thresholds protect the validity of the overall mechanism.

Consider a concrete example. A fund holds 60% of an SME. The agreement includes a drag along triggerable at 50%. A buyer offers to acquire 70% of the capital from the majority shareholders. Without a well-drafted tag along, minority shareholders remain captive alongside a new majority shareholder they did not choose.

Common drafting errors to avoid

Four errors recur in poorly drafted agreements.

First, an unclear threshold. A clause that refers to 'a majority of shareholders' without specifying the percentage is unenforceable.

Second, no reference price. Without a price-setting mechanism, the drag along clause cannot be executed in case of disagreement.

Third, missing notification procedure. A tag along without a notification procedure for the majority shareholder is a theoretical right only.

Fourth, incoherent timelines. A review clause set at seven years combined with a drag along triggerable at any time creates an imbalance.

Rigorous drafting requires validation by a company law professional.

How Overlord structures these clauses in your vehicle

Overlord structures your investment vehicle with a complete shareholders' agreement, integrating all three exit clauses in a coordinated manner.

Our approach is grounded in legal expertise. Our founder is a trained business lawyer. This translates into every agreement produced: calibrated thresholds, defined reference prices, coherent timelines.

For a vehicle structured as an SPV (Special Purpose Vehicle) or club deal, the private placement framework applies. Article L.411-2 of the French Monetary and Financial Code sets out the conditions. Drafting these exit clauses must account for this framework.

You receive an agreement drafted to your specifications, legally validated, and adapted to your vehicle type. Investment vehicle creation includes the drafting of the shareholders' agreement at no additional cost.

FAQ: liquidity clause, drag along, tag along

What is a liquidity clause in a shareholders' agreement?

A liquidity clause organises the exit of shareholders at an agreed term or upon a triggering event. It covers three mechanisms: drag along, tag along, and programmed exit (strategic review meeting, mandate, initial public offering).

What is the difference between a drag along and a tag along clause?

The drag along obliges minority shareholders to sell their shares when the majority shareholder accepts a global buyout offer. The tag along allows minority shareholders to sell on the same terms when the majority shareholder transfers their shares to a third party.

At what ownership threshold does the drag along clause trigger?

Standard thresholds range from 50% to 75% of the share capital. Without a clear threshold and reference price in the agreement, the drag along clause is unenforceable in practice.

Is the tag along clause mandatory to protect minority shareholders?

No statutory provision requires a tag along clause. Its inclusion in an agreement is nonetheless standard whenever a minority investor enters the share capital, as a counterpart to any drag along mechanism.

Can a drag along clause be inserted directly in a SAS's articles of association?

Yes. Articles L.227-13 to L.227-17 of the French Commercial Code authorise a SAS's articles of association to include forced transfer clauses. Statutory insertion reinforces enforceability compared to a purely contractual clause.

How do you combine a liquidity clause, drag along, and tag along in asingle agreement?

The three clauses are complementary. The drag along protects the interest in exiting. The tag along protects the interest in not remaining captive. The programmed exit clause guarantees a liquidity horizon. A balanced agreement provides all three with coherent thresholds, prices, and timelines.

What is the standard duration for a programmed liquidity clause?

Practice sets the horizon at five to seven years from the date of investment. Beyond that, the clause loses its function as a liquidity event and becomes a theoretical provision without an effective trigger.

Conclusion

The liquidity clause structures the exit provisions of your shareholders' agreement. Drag along, tag along, and programmed exit work together to balance shareholder interests. Rigorous drafting protects your investment vehicle and the value of your stake.

For further guidance, see our guides on the shareholders' agreement and the approval clause.